AMENDED SEC RULES REGARDING SAY-ON-PAY
By Bradley A. Robinson
February 15, 2011
On October 18, 2010, the SEC issued proposed rules in response to Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (The “Act”). After the public comment period ended on January 25, 2011, the SEC adopted final rules concerning shareholder approval of executive compensation and "golden parachute" compensation arrangements as required under the Act. It should be noted that the rules are substantially similar to the proposed rules, with some modifications and exclusions made in response to feedback received by the SEC during the comment period.
Frequency of Say-on-Pay Votes, or Say When on Pay (“SWOP”)
As originally announced under Rule 14 A(a)(2), say-on-pay votes required under the Act must occur at least every three years, starting with the first annual meeting taking place on or after January 21, 2011. In addition, companies will be required to hold a SWOP vote at least once every six years. In a SWOP vote, shareholders will vote on their preferences for how often (annually, biennially, triennially or abstain) the company will submit its say-on-pay vote. It should be noted that the company must indicate whether the vote will be binding or advisory. As of the announced rule changes, all companies may submit advisory votes to shareholders. Following the SWOP vote, a company must disclose on an SEC Form 8-K, within 150 days of the SWOP vote, the results of the vote and how often it will hold the say-on-pay vote.
Voting on SWOP Proposals
If a board of directors recommends one of the choices for frequency of say-on-pay proposals, the company must also clearly indicate that the proxy card provides four choices (annual, biennial, triennial or abstain) rather than an up or down vote on management’s recommendation. Issuers may vote uninstructed cards in accordance with management’s recommendation only if the following criteria are met:
- The company must provide a frequency recommendation in the proxy statement;
- The company must permit abstentions on the proxy card; and
- The company must indicate in boldface type, on the proxy card, how all uninstructed shares will be voted.
However, while the amended rules require all four choices to be on the proxy card, according to public comment, some proxy service providers currently only allow up to three choices in their current system. As such, the SEC has built in a grace period until December 31, 2011, during which time proxy cards may provide only three choices (every one, two, or three years). In such cases, no discretionary votes will be allowed where shareholders have not indicated a choice. It should be noted that both Eagle Rock and our affiliate, Registrar and Transfer Company, believe that fears concerning this issue are overblown. In fact, R&T has worked closely with Broadridge Financial Solutions and anticipates no problems with additional voting options on proxy cards.
Company Recommendations and Results
We note that companies are generally recommending that shareholders vote for say-on-pay votes once every three years. Here is a snapshot of overall board recommendations/ intentions for recommendation at the beginning of the season:
However, the wide support from issuers of triennial voting should not be mistaken for consensus within the investing community as a whole. Since the numbers behind the snapshot were obtained, there have been a number of high profile companies to put SWOP to a vote this year. Among these companies, Monsanto, Jacobs Engineering Group, Costco Wholesale and Johnson Controls have all recommended to shareholders that the company adopt the triennial vote. At all four companies, the majority of shareholder votes have gone to the annual option. Given these results and the breadth of shareholders at these companies, it seems clear that there will be significant support for the annual option going forward, even in the face of management opposition. There is some speculation that annual voting will become the “good corporate governance” gold standard on SWOP. As such, boards in favor of a non-annual say-on-pay vote should consider the possible necessity of significant shareholder outreach before the issue is put to a vote.
Generally, the announced rules for say-on-pay votes will also remain the same as the proposed rules from October. Under the final rules, companies subject to the federal proxy rules are required to provide shareholders with an advisory vote on executive compensation. As noted above, these say-on-pay proposals will be required a minimum of once every three years.
The rule amendments also require companies to provide disclosure in the annual meeting proxy statement regarding the say-on-pay vote, including whether the vote is non-binding, as well as disclosure in the Compensation Discussion and Analysis section of the proxy statement (CD&A) regarding whether, and how, companies have considered the results of the most recent say-on-pay vote.
The vote on executive compensation will cover not only overall executive compensation but the disclosure and the manner of that disclosure presented in the CD&A, compensation tables, and any other narrative discussing compensation to named executives contained in the proxy statement.
Under the SEC's new rules, companies also are required to provide additional disclosure regarding "golden parachute" compensation arrangements with named executive officers in connection with merger transactions.
The "golden parachute" disclosure also is required in connection with other transactions, including going-private transactions and third-party tender offers, so that the information is available for shareholders no matter the structure of the transaction.
The rules require companies to provide a separate shareholder advisory vote to approve certain "golden parachute" compensation arrangements in connection with a merger, acquisition, consolidation, proposed sale or other disposition of all or substantially all assets. While the SEC does not require “golden parachute” disclosure in annual meeting proxy statements, issuers are encouraged to include information regarding these packages if the information is necessary to a shareholder’s understanding of overall executive compensation. Companies are required to comply with the golden parachute compensation shareholder advisory vote and disclosure requirements in proxy statements and other forms initially filed on or after April 25, 2011.
Exceptions and Exemptions
The SEC has also adopted a temporary exemption so that smaller reporting companies are not required to conduct say-on-pay and frequency votes until annual meetings occurring on or after Jan. 21, 2013. As with other issuers, smaller reporting companies are required to conduct the shareholder advisory vote on golden parachute compensation upon effectiveness of the rules.
The SEC has stated that “the delayed compliance date for the say-on-pay and frequency votes for smaller reporting companies is designed to allow those companies to observe how the rules operate for other companies, and should allow them to better prepare for implementation of the rules. Delayed implementation for these companies will allow the Commission to evaluate the implementation of the adopted rules by larger companies and provide the Commission with the additional opportunity to consider whether adjustments to the rule would be appropriate for smaller reporting companies before the rule becomes applicable to them.”
Issuers who are participants in the Trouble Assets Relief Program (“TARP”) will also be exempt from the say-on-pay frequency vote (SWOP) as well, due to already existing requirements under the program that mandate annual say-on-pay advisory votes for shareholders. However, upon repayment of indebtedness and other assets borrowed under the program, TARP participants must hold a SWOP vote at the first annual meeting following repayment.
Excluding Future Shareholder Proposals
Generally, issuers may request from the SEC that they be able to take “No Action”, or exclude a shareholder proposal from the proxy statement, when they are already in substantial compliance with the proposed shareholder action. The SEC has stated that, while shareholders may continue to submit executive compensation proposals to companies that are subject to the regulations regarding say-on-pay, by complying with current regulations, companies will be deemed to be in substantial compliance in some situations. While non-inclusive, the SEC has made clear that a company may exclude say-on-pay or frequency of say-on-pay proposals as substantially implemented only when it has instituted a policy on say-on-pay consistent with a majority vote by shareholders on SWOP.
ISS and Institutional Shareholder Guidance
ISS Guidelines and Policy
Under the 2011 Policy Updates, ISS has adopted a new policy in response to the Dodd-Frank Act. In line with the new ISS policy, ISS will recommend that shareholders vote for annual advisory votes on executive compensation.
Under its 2010 Policy Guidelines, ISS identified numerous problematic pay practices which could influence its vote recommendations. The 2011 Policy Updates identify a set of these pay practices that are considered “most egregious” under the problematic pay practices section of ISS’ executive compensation policies. ISS states that these pay practices in particular “carry significant weight” in ISS’ assessment of a company’s pay programs and may result in an adverse vote recommendation. We believe that it is likely that the updated policy on problematic pay practices could result in a significant increase in recommendations by ISS instructing shareholders to vote against executive compensation packages than companies (which have heretofore generally been TARP participants with a number of compensation restrictions already in place) have typically experienced in prior years.
It should be noted that ISS has changed its policy allowing issuers to rectify a problematic pay practice by committing to change the practice, going forward, in a separate filing. Starting this year, ISS will no longer allow companies to amend problematic pay practices in this manner.
Institutional Shareholder Guidance
As stated in the frequency on say-on-pay section above, there is currently no consensus in the investor community regarding how often issuers should hold say-on-pay votes. As evidenced by recent high profile votes on the matter, ISS is not alone among institutions that have expressed support for annual votes. We note that Walden Asset Management this fall sent a letter, co-signed by 9 other investors including AFCSME, AFL-CIO, Christian Brothers Investment Services, and the State of Connecticut expressing support for annual votes on say on pay. TIAA-CREF and the Council of Institutional Investors (“CII”) have also stated a preference for annual voting.
However, it should be noted that some institutional shareholders have expressed support for biennial and triennial votes as well. While not comprehensive, this list includes Black Rock, CalSTRS and the Carpenters Union. In addition, T. Rowe Price has stated that they may use a quantitative approach to frequency voting, identifying companies that have outlying compensation practices, both good and bad, and voting accordingly. There are also numerous investors who, like T. Rowe Price, have stated that they are open to arguments by issuers as to why they should not be subject to an annual vote. Generally it would appear that companies with good compensation practices in the past will be the most likely to receive support from institutions that are open to arguments made by companies that wish to vote on say-on-pay other that annually.
Given the distance between issuers and investors as to preferences on the SWOP proposals, it is clear that any issuers that intend to recommend that shareholders support a non-annual version of say-on-pay should engage in some form of shareholder outreach. Knowing who an issuer’s investors are should be the first step of many in the process for issuers who wish to avoid majority votes for annual say-on-pay.
Bradley A. Robinson, Esq., Managing Director of Eagle Rock Proxy Advisors, is responsible for Eagle Rock’s corporate governance advisory services and for assisting clients in analyzing and shaping their governance policies and practices.