Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

As previously reported, ISS had recommended a no vote for executive compensation for Tyco International.   Tyco’s efforts resulted it in decidedly beating ISS, with 70% of its shareholders voting to approve Tyco’s compensation plans.

The initial implications are huge.  Is this a harbinger that ISS’ consultants are under-qualified and issue error ridden recommendations, or that institutional investors do not back ISS’ non-market based recommendations?

Tyco stated ISS’ premise was that Tyco’s executive compensation program does not align the pay of its CEO with company performance.  Tyco believed this is clearly not the case. Tyco noted that  first and foremost, from year to year, well over half of its CEO’s compensation is delivered in the form of performance-based long-term equity awards and annual incentive compensation.  That reflects the Compensation and Human Resource Committee’s philosophy of placing the largest component of executive officer compensation in alignment with shareholder returns.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

It was bound to happen.  Some of this you cannot make up.

Span-America proposed a non-binding frequency proposal of every two years.  The initial 8-K indicated an annual preference (630,375 votes) instead of a biennial preference (607,743).
But wait.  An 8-K/A has been filed recasting vote results.  Annual votes  of  638,715 versus biennial votes of 717,096.

An obscure, small cap issuer for sure.  Can it happen again for a larger cap stock?  What do you think?

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The SEC has released the study required by an independent consultant pursuant to Section 967 of the Dodd-Frank Act.  The study examines the internal operations, structure and need for reform at the SEC.  The report draws two key conclusions.  First, the SEC has significant opportunity to further optimize its available resources.  Second, Congress should reflect on whether or not such optimization adequately meets its expectations for the agency’s efficiency and effectiveness.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The Consumer Financial Protection Bureau, or CFPB, implementation team is soliciting comments regarding forms for questions, complaints, and other information about consumer financial  products and services.  In order to collect data about the consumer financial market and facilitate the appropriate routing of, handling of, and response to complaints, questions, and other information concerning consumer financial products and services, the CFPB is developing online and paper intake methods which will have fields for persons to complete. The fields will help document information such as the type of contact; the substance of the complaint, question, or other information; contact information for the person making the contact and/or related persons; information about any subject incident and institution; and identifying information about the consumer or consumer’s household.  The public is invited to submit written comments concerning whether the intake of complaints, questions, and other information relating to consumer financial products and services is necessary for the proper performance of the functions of the CFPB, including whether the information will have practical uses.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

As proxy season progresses, companies are turning up the heat on ISS.   In the latest definitive materials filed, HP says they “vehemently” disagree with ISS.  HP cuts right to the hear of the issue, stating “As you know, in January 2011, we effected a transformation of HP’s Board of Directors, including adding five outstanding women and men to our Board to help move HP forward.  ISS Proxy Advisory Services is critical of our process for doing so and is recommending against the re-election of three of our other highly qualified director nominees as a result.  ISS is also recommending against our advisory vote on executive compensation.  As described below, we believe ISS’ recommendations are fundamentally flawed.”

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

As first reported on the Official Activist Investing Blog, Wachtell Lipton announced yesterday that it filed a petition with the SEC seeking to change Section 13(d) rules of the Securities Exchange Act of 1934.  Among other things, the petition asks that the 13D rules be changed to require 5% accumulations of public company stock to be disclosed in one day rather than ten.  The rulemaking would be permitted by Section 929R of the Dodd-Frank Act.

The rule making petition can be found here.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

We have taken another  look at the results of the say-on-pay frequency vote for issuers with a market cap of under $250 million and greater than $50 million.  It is still not possible to draw any firm conclusions as to whether smaller issuers will enjoy a higher probability of success recommending a triennial vote than larger issuers.  The reasons is issuers reporting in this segment still seem to be subject to controlling shareholders.

Recently, Biodel Inc., with a market cap of $53 million recommended, and had approved, a triennial frequency.  Officers and directors control about 20% of the stock with 15% held by institutions.

Alico Inc. recommended a triennial vote but their shareholders expressed an interest for an annual vote.  It looks like Alico forgot to check with its 50%+ controlling shareholder before making a recommendation.

Tellular (market cap $102.8 million, institutional ownership of 39%, insider ownership of 16%) and Daily Journal (market cap $100.1 million, institutional ownership of 7% and insider control of 29%) have succeeded in having triennial frequency votes approved.

On the other side of the ledger, Insteel Industries (market cap of $220.1 million, institutional ownership 74% and insider control of 9%) saw its shareholders express an interest for an annual frequency even though the board recommended triennial.

One interesting result we noted was NCI Building Systems.  Preferred Stock of that company is owned by Clayton, Dubilier & Rice.  While the preferred stock voted to approve executive compensation, the common stockholders voted resoundingly against it.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The SEC has adopted proposed rules on incentive-based compensation applicable to broker-dealers and investment advisors that have more than $1 billion in assets.  The rules are being  jointly approved by, and subject to the separate approval of,  the SEC and the Office of the Comptroller of the Currency, Treasury; Board of Governors of the Federal Reserve System; Federal Deposit Insurance Corporation; Office of Thrift Supervision, Treasury;  National Credit Union Administration; and the Federal Housing Finance Agency.

As Broc Romanek of thecorporatecounsel.net first pointed out on Twitter, the proposed rules are stamped “draft,” presumably because they have not yet been approved by all of the regulators.  To our knowledge, none of the other regulators have seen fit to send such a signal, such as the FDIC.

We were hoping that the SEC action would provide some more details on how the proposal would be implemented, such as the separate release proposed by the National Credit Union Administration.  That is not the case, so important details such as how all of this will be reported to the SEC are not yet known.

We also think that with these rules, being a member of the compensation committee of a large bank, with perhaps a large broker dealer operation and maybe a large investment advisory arm, has become a full time job.  It looks like duplicate rules and reporting will be applied to each separately regulated entity, and each business has its own risks inherent in its compensation programs.

Details on this one-size-fits-all regulated entities proposal follow.

Covered Broker Dealers and Investment Advisers

“Covered financial institutions” under the proposed rule include broker dealers and SEC registered investment advisers that have more than $1 billion in assets.  For brokers or dealers registered with the SEC, asset size would be determined by the total consolidated assets reported in the firm’s most recent year-end audited Consolidated Statement of Financial Condition filed pursuant to Rule 17a-5 under the Securities Exchange Act of 1934.  For investment advisers, asset size would be determined by the adviser’s total assets shown on the balance sheet for the adviser’s most recent fiscal year end. The proposed method of calculation for investment advisers is consistent with the SEC’s recent proposal that each investment adviser filing Form ADV Part 1A indicate whether the adviser had $1 billion or more in “assets,” defined as the total assets shown on the balance sheet for the adviser’s most recent fiscal year end.

Covered Persons

Only incentive-based compensation paid to “covered persons” would be subject to the requirements of the proposed rule. A “covered person” would be any executive officer, employee, director, or principal shareholder of a covered financial institution.  No specific categories of employees are excluded from the scope of the proposed rule, although it is the underlying purpose of the rulemaking to address those incentive-based compensation arrangements for covered persons or groups of covered persons that encourage inappropriate risk because they provide excessive compensation or pose a risk of material financial loss to a covered financial institution.

Incentive-Based Compensation Arrangement

Consistent with Section 956 of the Dodd-Frank Act, the proposed rule would apply only to incentive-based compensation arrangements. The proposed rule defines “incentive-based compensation” to mean any variable compensation that serves as an incentive for performance.  The definition is broad and principles-based to address the objectives of Section 956 in a manner that provides for flexibility as forms of compensation evolve. The form of payment, whether it is cash, an equity award, or other property, does not affect whether compensation meets the definition of “incentive-based compensation.”

There are types of compensation that would not fall within the scope of this definition.  Generally, compensation that is awarded solely for, and the payment of which is solely tied to, continued employment (e.g., salary) would not be considered incentive-based compensation.  Similarly, a compensation arrangement that provides rewards solely for activities or behaviors that do not involve risk-taking (for example, payments solely for achieving or maintaining a professional certification or higher level of educational achievement) would not be considered incentive-based compensation under the proposal. In addition, the proposing agencies do not envision that this definition would include compensation arrangements that are determined based solely on the employee’s level of fixed compensation and do not vary based on one or more performance metrics (e.g., employer contributions to a 401(k) retirement savings plan computed based on a fixed percentage of an employee’s salary). The proposed definition also would not include dividends paid and appreciation realized on stock or other equity instruments that are owned outright by a covered person. However, stock or other equity instruments awarded to a covered employee under a contract, arrangement, plan or benefit would not be considered owned outright while subject to any vesting or deferral arrangement (irrespective of whether such deferral is mandatory).

Reporting of Incentive Based Compensation

Section 956(a)(1) of the Dodd-Frank Act requires that a covered financial institution submit an annual report to its appropriate Federal regulator disclosing the structure of its incentive-based compensation arrangements that is sufficient to determine whether the incentive-based compensation structure provides covered employees with excessive compensation, fees, or benefits, or could lead to material financial loss to the covered financial institution. In order to fulfill this requirement, the proposed rule would establish the general rule that a covered financial institution must submit a report annually to its appropriate regulator or supervisor in a format specified by its appropriate Federal regulator that describes the structure of the covered financial institution’s incentive-based compensation arrangements for covered persons. The report must contain:

  • A clear narrative description of the components of the covered financial institution’s incentive-based compensation arrangements applicable to covered persons and specifying the types of covered persons to which they apply;
  • A succinct description of the covered financial institution’s policies and procedures governing its incentive-based compensation arrangements;
  • For larger covered financial institutions, a succinct description of any specific incentive compensation policies and procedures for the institution’s executive officers, and other covered persons who the board or a committee thereof determines under the proposed rule individually have the ability to expose the institution to possible losses that are substantial in relation to the institution’s size, capital, or overall risk tolerance;
  • Any material changes to the covered financial institution’s incentive-based compensation arrangements and policies and procedures made since the covered financial institution’s last report was submitted; and
  • The specific reasons the covered financial institution believes the structure of its incentive-based compensation plan does not provide covered persons incentives to engage in behavior that is likely to cause the covered financial institution to suffer a material financial loss and does not provide covered persons with excessive compensation.

Excessive Compensation

The proposed rule would implement Section 956(b) of the Dodd-Frank Act by prohibiting a covered financial institution from having incentive-based compensation arrangements that may encourage inappropriate risks (i) by providing excessive compensation or (ii) that could lead to a material financial loss.   The proposed rule would establish a general rule that a covered financial institution may not establish or maintain any incentive-based compensation arrangement, or any feature of any such arrangement, that encourages a covered person to expose the institution to inappropriate risks by providing that person with excessive compensation.  Specifically, under the proposed rule, compensation for a covered person would be considered excessive when amounts paid are unreasonable or disproportionate to, among other things, the amount, nature, quality, and scope of services performed by the covered person.  In making such a determination, the proposing agencies will consider:

  • The combined value of all cash and non-cash benefits provided to the covered person;
  • The compensation history of the covered person and other individuals with comparable expertise at the covered financial institution;
  • The financial condition of the covered financial institution;
  • Comparable compensation practices at comparable institutions, based upon such factors as asset size, geographic location, and the complexity of the institution’s operations and assets;
  • For post-employment benefits, the projected total cost and benefit to the covered financial institution;
  • Any connection between the individual and any fraudulent act or omission, breach of trust or fiduciary duty, or insider abuse with regard to the covered financial institution; and
  • Any other factors the regulating agency determines to be relevant.

Inappropriate Risks

Section 956(b)(2) of the Dodd-Frank Act requires the proposing agencies to adopt regulations or guidelines that prohibit a covered financial institution from establishing or maintaining any incentive-based compensation arrangement, or any feature of such an arrangement, that encourages a covered person to expose the institution to inappropriate risks that could lead to a material financial loss at the covered financial institution.

This prohibition will apply only to those incentive-based compensation arrangements for individual covered persons, or groups of covered persons, whose activities may expose the covered financial institution to a material financial loss. Such covered persons include:

  • Executive officers and other covered persons who are responsible for oversight of the covered financial institution’s firm-wide activities or material business lines;
  • Other individual covered persons, including non-executive employees, whose activities may expose the covered financial institution to a material financial loss (e.g., traders with large position limits relative to the covered financial institution’s overall risk tolerance); and
  • Groups of covered persons who are subject to the same or similar incentive-based compensation arrangements and who, in the aggregate, could expose the covered financial institution to a material financial loss, even if no individual covered person in the group could expose the covered financial institution to a material financial loss (e.g., loan officers who, as a group, originate loans that account for a material amount of the covered financial institution’s credit risk).

Larger Covered Financial Institutions

Deferral Arrangements Required for Executive Officers.

The proposed rule would establish a deferral requirement for larger covered financial institutions (i.e., generally those with $50 billion or more in total consolidated assets). At these covered financial institutions, at least 50 percent of the incentive-based compensation of an “executive officer” (as previously defined), would have to be deferred over a period of at least three years. The proposed rule also requires that deferred amounts paid be adjusted for actual losses or other measures or aspects or performance that are realized or become better known during the deferral period.

If a covered financial institution is required to use deferral, the proposed rule provides some flexibility in administering its specific deferral program. A covered financial institution may decide to release (or allow vesting of) the full deferred amount in a lump-sum only at the conclusion of the deferral period; alternatively, the institution may release the deferred amounts (or allow vesting) in equal increments, pro rata, for each year of the deferral period.

Special Review and Approval Requirement for Other Designated Individuals

Other individuals at a larger covered financial institution, beyond the institution’s executive officers, may have the ability to expose the institution to possible losses that are substantial in relation to the institution’s size, capital, or overall risk tolerance. In order to help ensure that the incentive compensation arrangements for these individuals are appropriately balanced, and do not encourage the individual to expose the institution to risks that could pose a risk of material financial loss to the covered financial institution, the proposed rule would require that, at a larger covered financial institution, the board of directors, or a committee thereof, identify those covered persons (other than executive officers) that individually have the ability to expose the institution to possible losses that are substantial in relation to the institution’s size, capital, or overall risk tolerance.  The proposal notes that these covered persons may include, for example, traders with large position limits relative to the institution’s overall risk tolerance and other individuals that have the authority to place at risk a substantial part of the capital of the covered financial institution.  In addition, the proposed rule would require that the board of directors, or a committee thereof, of the institution approve the incentive-based compensation arrangement for such individuals, and maintain documentation of such approval.

Under the proposal, the board (or committee) of a larger covered financial institution may not approve the incentive-based compensation arrangement for an individual identified by the board (or committee) unless the board (or committee) determines that the arrangement, including the method of paying compensation under the arrangement, effectively balances the financial rewards to the employee and the range and time horizon of risks associated with the employee’s activities.

Policies and Procedures

The proposing agencies believe that the incentive-based compensation practices of covered financial institutions should be supported by policies and procedures, appropriate to the size and complexity of the covered financial institution, to foster transparency of each covered financial institution’s incentive-based compensation practices and to promote compliance and accountability regarding the practices that the agencies propose to prohibit.  Accordingly, the proposed rule would require covered financial institutions to have policies and procedures governing the award of incentive-based compensation as a way to help ensure the full implementation of the prohibitions in the proposed rule.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The SEC has recently proposed two rules under the Dodd-Frank Act on credit ratings.  Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires federal agencies to review how existing regulations rely on credit ratings and remove such references from their rules as appropriate.

In one rulemaking, the SEC proposed rule amendments to remove references to credit ratings in certain rules and forms under the Investment Company Act of 1940, including rule 2a-7 governing the operations of money market funds.  Under the SEC’s proposal, a rating would no longer be a required element in determining which securities are permissible investments for a money market fund.  A security would instead be an eligible investment for a money market fund if the fund’s board or its delegate determines that the security presents minimal credit risks.  As under the current rule, funds would have to invest at least 97 percent of their assets in securities that the board has determined are issued by an issuer that has the highest capacity to meet its short-term financial obligations.  This latter standard is intended to be consistent with the highest credit rating category.  The SEC’s proposed rule amendments also would remove credit ratings in three other areas: repurchase agreements, certain business and industrial development company, or BIDCO, investments, and shareholder reports.

In another rulemaking, the SEC proposed rules that would remove credit ratings as one of the conditions for companies seeking to use short-form registration when registering securities for public sale.  The SEC’s proposed rule amendments would remove the NRSRO investment grade ratings condition included in SEC forms S-3 and F-3 for offerings of non-convertible securities, such as debt securities.   And, instead of ratings, the new short-form test for shelf-offering eligibility of companies would be tied to the amount of debt and other non-convertible securities they have sold in the past three years.  For instance, under the proposed amendments, Form S-3 and Form F-3 would be revised to remove the eligibility standard based on an investment-grade rating by an NRSRO.  Instead, the company seeking to qualify for short-form registration, as well as the expedited “shelf” process, to register non-convertible securities would have to have issued over $1 billion of non-convertible securities for cash in registered, primary offerings within the previous three years.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

Section 747 of the Dodd-Frank Act prohibits three “disruptive” trading practices and grants the CFTC authority to enforce the prohibitions. Under Section 747, it is unlawful for any person to engage in any trading, practice, or conduct on or subject to the rules of a registered entity (i.e., a designated contract market or swap execution facility) that—

(A) violates bids or offers;
(B) demonstrates intentional or reckless disregard for the orderly execution of transactions during the closing period; or
(C) is, is of the character of, or is commonly known to the trade as, “spoofing” (bidding or offering with the intent to cancel the bid or offer before execution).

The CFTC has issued a proposed interpretive order to provide market participants with guidance on the scope of these statutory prohibitions. Comments will be due 60 days after publication of the proposed order in the federal register.

Violating Bids and Offers

The Commission interprets this requirement as prohibiting any person from buying a contract at a price that is higher than the lowest available offer price and/or selling a contract at a price that is lower than the highest available bid price. Of the three prohibited trading practices under Section 747, this is the only one that is a per se offense—no intent or other scienter is required. The Commission recognizes that this requirement will not apply where a person is unable to violate a bid or offer—i.e., when a person is utilizing an electronic trading system where algorithms automatically match the best bid and offer.

Orderly Execution of Transactions During the Closing Period
As specified in the statute, this prohibition is based on a scienter requirement of intent or recklessness—accidental, or even negligent, trading conduct is not a violation. The Commission interprets the closing period to be generally defined as the period in the contract or trade when the daily settlement price is determined under the rules of the subject trading facility. The Commission will use existing concepts of orderliness of markets when assessing whether execution of transactions complies with the rule, such as:

– rational relationships between consecutive prices;
– a strong correlation between price changes and the volume of trades;
– levels of volatility that do not materially reduce liquidity;
– accurate relationships between the price of a derivative and the underlying physical commodity or financial instrument; and
– reasonable spreads between contracts for near months and remote months.

Spoofing

In the view of the Commission, a “spoofing” violation requires that a person intend to cancel a bid or offer before execution. Orders, modifications, and cancellations will not be classified as “spoofing” if they were submitted as part of a legitimate, good-faith attempt to consummate a trade. Thus, the legitimate, good-faith cancellation of partially filled orders is not a violation. When distinguishing between legitimate trading involving partial executions and “spoofing” behavior, the Commission will evaluate the market context, the person’s pattern of trading activity (including fill characteristics), and other relevant facts and circumstances.

“Spoofing” also includes:

(i) submitting or cancelling bids or offers to overload the quotation system of a registered entity;
(ii) submitting or cancelling bids or offers to delay another person’s execution of trades; and
(iii) submitting or cancelling multiple bids or offers to create an appearance of false market depth.

However, the “spoofing” provision is not intended to cover non-executable market communications such as requests for quotes and other authorized pre-trade communications.