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

An article in yesterday’s Wall Street Journal provides a good, short overview of the issues and differing viewpoints surrounding the SEC’s upcoming broker-dealer fiduciary duty rulemaking.   As the article correctly points out, registered investment advisers have long been held to a fiduciary standard vis-a-vis their clients.  The brokerage industry has generally resisted having any fiduciary obliations imposed on its activities.  Stay tuned for what most certainly will be a heavily debated part of the implemenation of the Dodd-Frank Act.

Section 926 of the Dodd-Frank Act directs the SEC to issue rules which would prevent the use of Regulation D Rule 506 offerings by certain “bad actors.”  The Dodd-Frank 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. 

 The “bad actor” disqualifications of Regulation A can be found in Rule 262 of the Securities Act rules.  The disqualifications apply to all officers, directors and beneficial owners of 10% or more of any class of securities.  Assuming the SEC uses similar concepts to implement the Dodd-Frank Act, this has a number of implications for private companies raising capital.  Companies will need to be careful when selecting board members and officers to make sure they are not disqualified.  Likewise, care must be taken as to whom securities are sold to prevent a 10% beneficial owner from disqualifying the company.  In addition, modifications may be necessary to subscription documents.

 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.  For example, it’s not unusual for a public company to rely on Regulation D when privately placing securities in an acquisition.

The SEC has announced that it will “consider” the adoption of proxy access rules on August 25, 2010.  It is probably a safe bet that when they are done “considering” the issue they will adopt final rules.  Sometimes the final rules are not available for immediate publication and availability is delayed for a couple of weeks, so it may  be difficult to tell for a period of time what actually has been adopted.  In the meantime, refresh your recollection on the SEC’s prior proposal which Jill posted here, and my analysis of some of the problems with the proposed rule here.  This will change the corporate governance landscape, and the only thing I can predict is the rules will be difficult to understand.

The Dodd-Frank Wall Street Reform and Consumer Protection Act will require listed public companies to hold periodic say-on-pay shareholder votes.  Say-on-pay votes are non-binding votes on the compensation of an issuer’s executive officers.  Ethan has posted an example of a say-on-pay vote here.

  A  June 2010 Towers Watson survey found that only 12% of respondents said they are very well prepared for the say-on-pay legislation, while 46% said they were somewhat prepared. Just under one-fourth of respondents (22%) did not know if their companies were ready. 

 So the question becomes, what can be done to prepare for your first say-on-pay vote?  It is a little difficult to come up with an exhaustive list because the SEC has not yet published any proposed rules.  However, it should be noted that this provision of the Dodd-Frank Act becomes effective for shareholder meetings on or after January 21, 2011 even if the SEC does not issue any rules.  Since the SEC now has a heavy rule-making agenda, and they might not illuminate the issuer universe for some time, it is probably best to start preparation now.  As Mark points here, preparation is important because brokers will not be able to vote uninstructed shares on say-on-pay matters.

 The first step is to assemble your team.  Members should include human resources, investor relations, internal and external counsel, compensation consultants and possibly a proxy solicitor.

 The team should then review current executive pay practices.  Are there any practices that could be criticized as excess, resulting in a pay-for-performance disconnect or the like?  If there are undesirable practices, can steps be taken to eliminate them?  The following are some of the items included on Riskmetric’s list of problematic pay practices:

 Multi-year guarantees for salary increases, non-performance based bonuses, and equity compensation;

  • Including additional years of unworked service that result in significant additional benefits, without sufficient justification, or including long-term equity awards in the pension calculation;
  • Perquisites for former and/or retired executives, and extraordinary relocation benefits (including home buyouts) for current executives;
  • Change-in-control payments exceeding 3 times base salary and target bonus; change-in-control payments without job loss or substantial diminution of duties; or
  • New or materially amended agreements that provide for an excise tax gross-up.

 One of the key steps in preparing for say-on-pay will then be to concisely explain to your shareholders your compensation policies and practices.  This of course places a premium on making sure the compensation discussion and analysis included in your proxy statement is clear and concise.  That should be reviewed and revisited and cleaned-up if necessary.

 Where do your key investors stand on compensation issues?  It is time to find out.  Discuss your pay practices with them or review their voting policies or both.

 Finally, as the process unfolds, known and unknown wrinkles will develop so it will be important to stay tuned for new issues.  For instance, the Dodd-Frank Act requires issuers to vote on whether the say-on-pay referendum should take place every one, two or three years.  Other than beginning to think about what interval you would recommend to your shareholders to adopt for a say-on-pay vote, there are by-law and state law questions that will crop up.  How do you know which of the three timing options has been approved if none receive a majority of the votes cast?  Hopefully the SEC will issue rules that clarify these matters.

Under the Dodd-Frank Act, listed issuers will be required to include a say-on-pay vote for any shareholder meeting occurring on or after January 21, 2011.  A say-on-pay-vote is a nonbinding shareholder vote on an issuer’s executive compensation.  Financial institutions that were recipients of funds under the Troubled Asset Relief Program, also known as TARP, have been required to include say-on-pay votes in their proxy statements.  So there are a number of examples to look at.

 U.S. Bancorp’s 2010 proxy disclosure for its say-on-pay resolution is set forth below.  As you can see, it is well written and advances strong and succinct arguments as to why its compensation package is reasonable.

 The U.S. Bancorp disclosure is as follows:


 The Board of Directors is committed to excellence in governance and is aware of the significant interest in executive compensation matters by investors and the general public, and in the idea of U.S. public corporations proposing advisory votes on compensation practices for executive officers (commonly referred to as a “say-on-pay” proposal). Our Board has determined that providing shareholders with an advisory vote on executive compensation may produce useful information on investor sentiment with regard to the Compensation and Human Resources Committee’s executive compensation philosophy, policies, and procedures.

 The Company has designed its executive compensation program to attract, motivate, reward and retain the senior management talent required to achieve our corporate objectives and increase shareholder value. We believe that our compensation policies and procedures are centered on a pay-for-performance philosophy and are strongly aligned with the long-term interests of our shareholders. See “Executive Compensation–Compensation Discussion and Analysis.”

 As a result, the Company is presenting this proposal, which gives you as a shareholder the opportunity to endorse or not endorse our executive pay program by voting for or against the following resolution:

 “RESOLVED, that the shareholders approve the compensation of U.S. Bancorp executives, as disclosed in the Compensation Discussion and Analysis, the compensation tables, and the related disclosure contained in the proxy statement.”

 The Board of Directors urges shareholders to endorse the compensation program for our executive officers by voting FOR the above resolution. As discussed in the Compensation Discussion and Analysis contained in this proxy statement, the Compensation and Human Resources Committee of the Board of Directors believes that the executive compensation for 2009 is reasonable and appropriate, is justified by the performance of the Company in an extremely difficult environment and is the result of a carefully considered approach.

 In deciding how to vote on this proposal, the Board urges you to consider the following factors, many of which are more fully discussed in the Compensation Discussion and Analysis:

  •  Our company has been a top performer among its peers by numerous industry measures for many years, and our Compensation and Human Resources Committee has designed the compensation packages for our senior executives to be competitive with the compensation offered by those peers with whom we compete for management talent.
  • Unlike many of our peers, our company was profitable in every quarter of 2009 and 2008.
  • There is no history at this company of the compensation practices evidenced at some large financial institutions that have received so much recent negative publicity.
  •  We recognize the need to fairly compensate and retain a senior management team that has produced some of the best operating results in the financial services industry over the past several years.

 Because your vote is advisory, it will not be binding upon the Board of Directors. However, the Board values shareholders’ opinions and the Compensation and Human Resources Committee will take into account the outcome of the vote when considering future executive compensation arrangements.

 The Board of Directors recommends that you vote FOR approval of U.S. Bancorp’s executive compensation program as described in the Compensation Discussion and Analysis and the compensation tables and otherwise in this proxy statement. Proxies will be voted FOR approval of the proposal unless otherwise specified.

The Federal Reserve Sytsem has issued a proposed rule under Regulation Z issued pursuant to the Truth in Lending Act.  The proposed rule would implement Section 1461 of the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act.  Section 1461 amends TILA to provide a separate, higher threshold for determining coverage of the Board’s escrow requirement applicable to higher-priced mortgage loans, for loans that exceed the maximum principal balance eligible for sale to Freddie Mac.


On August 20, 2010, commencing at 9:00 a.m. and ending at 12:00 p.m., staff of the SEC and CFTC (the “Agencies”) will hold a public roundtable discussion at which invited participants will discuss governance and conflicts of interest in the context of certain authority that Sections 726 and 765 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) granted to the Agencies respectively.  Find more information here.

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.

The National Association of Mutual Insurance Companies (NAMIC) issued this press release in response to the Dodd-Frank Act.  As we noted here, Dodd-Frank establishes a new agency, the Federal Insurance Office (FIO).  According to NAMIC, “the FIO will play an important role in helping guide federal policy and trade negotiations with regard to property/casualty insurance, . .  . however, we must remain vigilant to ensure that it is not allowed to expand beyond its intent. The FIO was designed to, and should, work in concert with the state regulatory system, not duplicate it.”

As the CFTC’s first move in its monumental task of implementing the swap trading provisions of Dodd-Frank, the agency yesterday announced a joint Advanced Notice of Proposed Rulemaking (“ANOPR”) with the SEC seeking comments on the many critical definitions that will establish the scope of the agencies’ jurisdiction and of important categories that will affect the level of regulation faced by companies trading energy swaps.  Notably, these definitions include the following terms:

  • “Swap” – which will establish the boundaries of CFTC jurisdiction under the Dodd-Frank amendments to the Commodity Exchange Act;
  • “Swap dealer” – which will subject qualifying entities to new registration, capital and margin, reporting, recordkeeping, and business conduct requirements and will depend on critical concepts such as “market-making,” regularly entering into swaps “as an ordinary course of business” for one’s own account, and a “de minimis” exception; and
  • “Major swap participant” – which will subject qualifying entities to the same kinds of requirements imposed on swap dealers and will depend on critical concepts such as “substantial positions” in swaps, hedging of “commercial risk” (the so-called end user exemption), and the creation of “substantial counterparty exposure” or “serious adverse effects” on the financial stability of U.S. markets.

 Companies engaged in swap transactions in the energy sector, whether to speculate or to hedge risk, will have a tremendous amount at stake in this first of the over 60-plus rulemakings expected from the CFTC (which the CFTC has grouped into 30 categories) regarding the swap trading provisions in Dodd-Frank.  Comments on the ANOPR, which will inform draft definitions subject to further comment after publication in a CFTC NOPR, are due within 30 days of publication of the ANOPR in the Federal Register.