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The SEC has issued its final say-on-pay rules (Release No. 33-9178; 34-63768).  The good news is the final rules are mostly tweaks, and issuers’ advance planning to date will be fruitful.  In addition, smaller reporting companies will be exempt from say-on-pay and frequency votes for any meeting held prior to January 21, 2013 (but not approval of so called “golden parachute compensation” in connection with an acquisition).  On the downside, the SEC did not grant any significant advantages to submitting “golden parachute compensation” to a shareholder advisory vote at an annual meeting to take advantage of an exception from including the advisory vote on golden parachute compensation in connection with a merger.

Some of the more important changes are highlighted below.

Form of Say-on-Pay Resolution Approving Compensation

The final rule does not require issuers to use any specific language or form of resolution to be voted on by shareholders.  As the SEC noted in the proposing release, however, the shareholder advisory vote must relate to all executive compensation disclosure disclosed pursuant to Item 402 of Regulation S-K.  Section 14A(a)(1) of the Exchange Act requires that the shareholder advisory vote must be “to approve the compensation of executives, as disclosed pursuant to [Item 402 of Regulation S-K] or any successor thereto.”  The SEC has added an instruction to Rule 14a-21(a) to indicate that this language from Section 14A(a)(1) should be included in an issuer’s resolution for the say-on-pay vote.  The SEC has also provided the following non-exclusive example of a resolution that would satisfy the applicable requirements:

“RESOLVED, that the compensation paid to the company’s named executive officers, as disclosed pursuant to Item 402 of Regulation S-K, including the Compensation Discussion and Analysis, compensation tables and narrative discussion is hereby APPROVED.”

We do not see any reason not to use the example provided by the SEC.  Perhaps somewhat inconsistently, the SEC declined to give any example of a resolution for the frequency vote.

New 8-K Reporting Requirement; 10-K and 10-Q Disclosure Eliminated

The SEC proposed amendments to Form 10-Q and Form 10-K to require additional disclosure regarding the issuer’s decision to adopt a policy on the frequency of say-on-pay votes following a shareholder advisory vote on frequency.  After considering the comments, the SEC is not adopting amendments to Form 10-Q and Form 10-K.  Instead, the SEC is adopting a new Form 8-K Item to require disclosure of the issuer’s decision on the frequency of say-on-pay votes.

Under the final rule, Item 5.07 of Form 8-K requires an issuer to disclose its decision regarding how frequently it will conduct shareholder advisory votes on executive compensation following each shareholder vote on the frequency of say-on-pay votes.  To comply, an issuer will file an amendment to its prior Form 8-K filings under Item 5.07 that disclose the preliminary and final results of the shareholder vote on frequency.  This amended Form 8-K will be due no later than 150 calendar days after the date of the end of the annual or other meeting in which the vote required by Rule 14a-21(b) took place, but in no event later than 60 calendar days prior to the deadline for the submission of shareholder proposals under Rule 14a-8 for the subsequent annual meeting, as disclosed in the issuer’s proxy materials for the meeting at which the frequency vote occurred.  In the amended Item 5.07 Form 8-K, the issuer must disclose its determination regarding the frequency of say-on-pay votes.

The SEC also adopted a technical amendment to Item 5.07(b) of Form 8-K to facilitate reporting of shareholder votes on frequency.  Item 5.07 of Form 8-K generally requires an issuer to “state the number of votes cast for, against, or withheld, as well as the number of abstentions and broker non-votes as to each such matter….”  The final rules clarify that, with respect to the vote on the frequency of say-on-pay votes, the issuer will be required to disclose the number of votes cast for each of 1 year, 2, years, and 3 years, as well as the number of abstentions.

Consideration of Say-on-Pay Vote—Only the Most Recent

The SEC proposed to amend Item 402(b)(1) to add to the mandatory CD&A topics whether, and if so, how an issuer has considered the results of previous shareholder votes on executive compensation required by Section 14A or Rule 14a-20 in determining compensation policies and decisions and, if so, how that consideration has affected its compensation policies and decisions.  In the final rule the SEC limited the mandatory topic to “the most recent say-on-pay vote.”  The SEC also stated that consistent with the principles-based nature of CD&A, issuers should address their consideration of the results of earlier say-on-pay votes to the extent such consideration is material to the compensation policies and decisions discussed.

Enhanced Frequency Disclosure

Proxy statements will now have to disclose pursuant to Item 24 of Schedule 14A the current frequency of say-on-pay votes and when the next scheduled say-on-pay vote will occur.

Voting of Uninstructed Proxy Cards

In response to comment, the SEC noted that issuers may vote uninstructed proxy cards in accordance with management’s recommendation for the frequency vote only if the issuer follows the existing requirements of Rule 14a-4 to (1) include a recommendation for the frequency of say-on-pay votes in the proxy statement, (2) permit abstention on the proxy card, and (3) include language regarding how uninstructed shares will be voted in bold on the proxy card.  Make sure this is on your checklist.

No Flexibility in Golden Parachute Disclosures for Annual Meetings

Consistent with Section 14A(b)(2) of the Exchange Act and the SEC proposal, issuers will not be required to include in a merger proxy a separate shareholder vote on the golden parachute compensation if required disclosure of that compensation had been included in the executive compensation disclosure that was subject to a prior vote of shareholders under Section 14A(a)(1) of the Exchange Act and Rule 14a-21(a).   Note that Section 14A(b)(2) requires only that the golden parachute arrangements have been subject to a prior shareholder vote under Section 14A(a)(1); such arrangements need not have been approved by shareholders.

For issuers to take advantage of this exception, however, the executive compensation disclosure subject to the prior shareholder vote must have included Item 402(t) disclosure of the same golden parachute arrangements. The exception will be available only to the extent the same golden parachute arrangements previously subject to an annual meeting shareholder vote remain in effect, and the terms of those arrangements have not been modified subsequent to the Section 14A(a)(1) shareholder vote.

As proposed and adopted, if the disclosure pursuant to Item 402(t) has been updated to change only the value of the items in the “Golden Parachute Compensation Table” to reflect price movements in the issuer’s securities, no new shareholder advisory vote under Section 14A(b)(1) will be required.  However, the SEC stated any change that would result in an IRC Section 280G tax gross-up becoming payable as a change in terms triggering such a separate vote, even if such tax gross-up becomes payable only because of an increase in the issuer’s share price.

The SEC also stated that changes in compensation because of a new named executive officer, additional grants of equity compensation in the ordinary course, and increases in salary, are significant changes to the golden parachute compensation disclosure and should be subject to a shareholder vote.  Because a shareholder vote would already have been obtained on portions of the arrangements, however, only the new arrangements and revised terms of the arrangements previously subject to a shareholder vote will be subject to the merger proxy separate shareholder vote.  We believe however that submitting such isolated changes have the likelihood of the advisory vote being limited to immaterial maters and causing shareholder confusion.

Backtracking on Rule 14a-8 Exclusions

The SEC’s proposed amendment to Rule 14a-8 would have added a note to Rule 14a-8(i)(10) to clarify the status of shareholder proposals that seek an advisory shareholder vote on executive compensation or that relate to the frequency of shareholder votes approving executive compensation.  Rule 14a-8 provides eligible shareholders with an opportunity to include a proposal in an issuer’s proxy materials for a vote at an annual or special meeting of shareholders. An issuer generally is required to include the proposal unless the shareholder has not complied with the rule’s procedural requirements or the proposal falls within one of the rule’s 13 substantive bases for exclusion. One of the substantive bases for exclusion, Rule 14a-8(i)(10), provides that an issuer may exclude a shareholder proposal that has already been substantially implemented.

The SEC proposed adding a note to Rule 14a-8(i)(10) to permit the exclusion of a shareholder proposal that would provide a say-on-pay vote or seeks future say-on-pay votes or that relates to the frequency of say-on-pay votes, provided the issuer has adopted a policy on the frequency of say-on-pay votes that is consistent with the plurality of votes cast in the most recent vote in accordance with Rule 14a-21(b).  The final rule only permits exclusion of a shareholder proposal if a policy is adopted consistent with a majority of votes cast.

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