Set forth below is a summary of the principal corporate governance and corporate finance provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or the “Act”) for non-financial institutions.
Voting by Brokers. Under Section 957 of the Dodd-Frank Act, national securities exchanges are required to prohibit broker voting with respect to the election of directors, executive compensation and any other significant matter, as determined by the SEC. As broker voting for election of directors has already been eliminated by the New York Stock Exchange, that directive of itself is not bound to be problematic.
It is unknown whether the rule-making process will ultimately make it more difficult for public companies to obtain quorums at annual meetings. If the exchanges were to eliminate the ratification of auditors as a permissible exercise of broker votes, public company annual meetings could be significantly affected.
Mandatory “Say-on-Pay” and “Golden Parachute” Vote. Section 951 of the Act requires the proxy statement for a meeting of shareholders to include, at least once every three years, a separate non-binding resolution to approve the compensation of executives. In addition, not less than every six years, a proxy statement must include a separate resolution to determine whether such vote must occur every one, two or three years.
Separately, at any meeting where shareholders are asked to approve an acquisition, merger, consolidation, proposed sale or other disposition of substantially all assets, the proxy statement must include a non-binding resolution on any agreements or understandings the issuer has with its named executive officers concerning any type of compensation that may become payable to the executive officers in connection with the transaction. The vote is not required if the agreements have been previously approved in another non-binding say-on-pay vote.
These provisions apply to shareholder meetings occurring more than six months after the date of enactment of the Act. It is important to note that these provisions, unlike many others, are not dependent upon any SEC rule making and are automatically effective.
In the past, “say-on-pay” votes may have been regarded by public companies as mere formalities or easily obtained forms of shareholder approval, since brokers have typically voted shares in favor of management, assuring passage of the proposal in most cases. That cannot occur in the future as broker voting on “say-on-pay” is eliminated by the Dodd-Frank Act.
Public companies outside of the financial institution industry need to monitor the rule-making process to determine if a preliminary proxy will need to be filed for the “say-on-pay” vote. Currently, Rule 14a-6 requires a preliminary proxy to be filed with the SEC for a “say-on-pay” vote, as the Rule only carves out “say-on-pay” votes from the requirement to file a preliminary proxy for certain financial institutions pursuant to Section 111(e)(1) of the Emergency Economic Stabilization Act of 2008.
Proxy Access. Section 971 of the Act provides that the SEC may prescribe rules that permit shareholders to include nominees for election as directors in proxy statements and prescribe certain procedures the issuer must follow. This provision will eliminate debate that has occurred in the past as to whether the SEC has power to adopt proxy access rules. While the SEC is not required to adopt proxy access rules, it is widely expected that it will do so.
Independence of Compensation Committees. Section 952 of the Act containes extensive provisions regarding compensation committees, including:
- requiring national securities exchanges to prohibit the listing of issuers that have compensation committees which are not independent;
- requiring the SEC to identify factors that affect the independence of compensation consultants, legal advisors or other advisors to the compensation committee;
- requiring the SEC to adopt disclosure rules regarding whether the issuer retained a compensation consultant, whether the work of the compensation consultant raised any conflict of interest and, if so, the nature of the conflict and how the conflict is being addressed; and
- providing the compensation committee explicit authority to retain a compensation consultant, legal counsel and other advisors.
Executive Compensation Disclosures. Section 953 of the Act requires the SEC to adopt rules which require additional disclosures with respect to executive compensation in the following areas:
- the relation of executive compensation actually paid and the financial performance of the issuer;
- the median annual compensation of all employees of the issuer excluding the Chief Executive Officer;
- the annual total compensation of the Chief Executive Officer; and
- the ratio of Chief Executive Officer compensation to the median annual compensation of all employees of the issuer excluding the Chief Executive Officer.
The text of Section 953 of the Act is ambiguous and the SEC could interpret it to require disclosures other than that set forth above.
Compensation Clawbacks. Section 954 of the Act requires national securities exchanges to adopt rules as directed by the SEC, which rules will require issuers to develop and implement a policy providing:
- for disclosure of an issuer’s policy on incentive compensation that is based on financial information required to be reported under securities laws; and
- that, if an accounting restatement is prepared, the issuer will recover any excess incentive-based compensation from any current or former executive officer who received such incentive-based compensation in the three preceding years.
Employee and Director Hedging. Section 955 of the Act directs the SEC to adopt rules requiring disclosure in proxy statements for annual meetings regarding whether employees or directors of the issuer are permitted to enter into hedging transactions with respect to equity securities granted to employees or directors as compensation or other equity securities of the issuer held by employees or directors.
Chairman and CEO Structures. Section 972 of the Act directs the SEC to adopt rules requiring disclosure in annual proxy statements as to why the issuer has chosen the same or different persons to serve as Chairman of the Board of Directors and the Chief Executive Officer.
Elimination of Internal Control Reports for Non-Accelerated Filers. Section 989G of the Act amends Section 404 of the Sarbanes-Oxley Act so that non-accelerated filers are not required to provide an auditor’s attestation on management’s assessment of internal controls. However, the provision of the Sarbanes-Oxley Act that requires an assessment by management of internal controls of an issuer is not affected by this amendment. We believe public companies exempted by the Dodd-Frank Act should consider whether obtaining an auditor’s attestation is desirable, particularly those who may soon meet the definition of an “accelerated filer” or those who may seek to be acquired or raise money in the capital markets.
Adjusting the Accredited Investor Standard. Section 413 of the Act directs the SEC to adjust the net worth standard in the definition of accredited investor used in Regulation D. Prior to adoption of the Dodd-Frank Act, a person was an accredited investor if the person had a net worth, or a joint net worth with the person’s spouse, of not less than $1,000,000. Section 413 modifies this standard by excluding the value of the person’s primary residence from the net worth calculation. It appears that the $1,000,000 standard excluding the value of a person’s primary residence was immediately applicable upon adoption of the Act. The Act also directs the SEC to review the definition of accredited investor at least every four years.
“Bad Actor” Disqualifications From Regulation D Offerings. Section 926 of the Act directs the SEC to issue rules which would prevent the use of Regulation D Rule 506 offerings by certain “bad actors.” The Act directs the SEC to adopt rules similar to the current disqualifiers in Regulation A. The SEC rules must also prohibit Rule 506 offerings by persons subject to final orders which bar them from association with entities regulated by certain authorities, such as state securities commissions, or that have been convicted of any felony or misdemeanor in connection with the purchase or sale of any security. We recommend that public companies revise their annual officer and director questionnaires to solicit appropriate inquiries to determine eligibility for Rule 506 offerings if that is a likely method of corporate fund raising.