Alert > Securities
Litigation / Investment
Management / Broker-Dealer / Corporate Governance
and Compliance
Senate's Financial Reform Bill Impacts Executive Compensation Rules and Corporate Governance
On May 20, 2010, the Senate passed the sweeping 1,600-page
Restoring American Financial Stability Act of 2010 (the “Act”)
containing significant proposed reforms on a wide array of issues
affecting the financial services industry and companies with
publicly-traded stock on U.S. exchanges. Other Bingham McCutchen LLP
client alerts will address significant market regulatory issues arising
from the legislation; here we focus on the Act’s potential implications
for executive compensation and corporate governance, and in particular
on the impending new standards for “say-on-pay,” proxy access,
compensation committee independence, compensation clawbacks, and
shareholder suits. Significantly, the Act’s corporate governance reforms
(and insurance company reforms) represent a shift toward federalization
of many issues previously regulated solely by the states.
The Senate bill must now be reconciled with financial reform
legislation passed by the House in December 2009. Representative Barney
Frank of Massachusetts, slated to lead the conference committee charged
with reconciling the House and Senate bills, has announced his intention
to present the final bill for President Obama’s signature by July 4th.
Several key provisions appear in both bills; to the extent the two bills
differ, legislative leaders indicate they expect swift resolution.
The Senate bill authorizes the SEC to prohibit listing on a U.S.
exchange of any public companies failing to adopt the corporate
governance standards set forth in the Act. The SEC would continue to
have the authority to exempt companies from any of the requirements
based on size, market capitalization, number of shareholders or other
criteria that the SEC deems appropriate, along with the ability to
provide for transition and cure periods.
Investment companies will be among those watching the reconciliation
process closely, as Rule 20a-1 under the Investment Company Act of 1940
could operate to apply the SEC’s new proxy requirements to registered
funds. Further, listed closed-end funds and exchange-traded funds (ETFs)
could be affected by proposed corporate governance requirements for
listing on an exchange.
Executive Compensation
In the wake of public outrage from the compensation packages paid by
TARP participant companies, both the Senate and the House have focused
much of their corporate governance efforts on executive compensation
issues.
Provisions included in both the Senate and House bills
- “Say-on-Pay.” Following the lead of companies listed on U.K.
exchanges, where “say-on-pay” has been mandatory since 2002, both the
Senate and House bills require annual proxies to include a non-binding
“say-on-pay” resolution. The resolution would give shareholders,
beginning six months after the legislation’s enactment, the opportunity
to cast an advisory vote on executive compensation disclosed pursuant to
Item 402 of Regulation S-K. As has been widely reported in the
financial press, shareholder anger over executive compensation has led
several large public companies voluntarily to initiate shareholder
advisory votes on executive pay. Congress also required companies that
received TARP funds to provide for “say-on-pay” resolutions. At least
three companies to date have already seen shareholders reject executive
pay packages in “say-on-pay” votes. The Senate bill would also prohibit
brokers from voting on “say-on-pay” proposals without instructions from
the beneficial owners of the shares being voted.
Critics of “say-on-pay” have noted the amount of power the change would
place in the hands of proxy advisory firms, which have developed
extensive compensation guidelines in connection with their issuance of
proxy advice. Some proxy advisory firms also maintain consulting arms
advising the companies whose proposals they purport to assess when
issuing their ratings and proxy vote recommendations. The concentration
of power in such firms, along with potential conflicts raised by their
consulting arms, has caused some to advocate for additional oversight of
such organizations in order to prevent “gatekeeper creep,” similar to
that now being alleged against financial credit rating agencies. As SEC
Chair Mary Schapiro told the Practicing Law Institute last November:
“...we’ll be
asking about the role of proxy advisory firms in corporate voting. Given
the influence that these firms’ recommendations have on corporate
voting outcomes, we’ll probe the need for rules to ensure that advisory
firms are basing their research and recommendations on accurate and
reliable information. And, that they are providing adequate disclosure
of any conflicts of interest they may have in providing voting
recommendations.”
Proxy advisory firms may thus face future regulation. Credit rating
agencies appear to be facing such regulation now: an amendment
introduced by Senator Al Franken would create a Credit Rating Agency
Board imposing far greater oversight of credit rating agencies.
- Compensation Committee Independence. Both the Senate and
House bills require the SEC to direct the securities exchanges to
include as a listing requirement that executive compensation be set by
“independent” directors. In defining “independence,” the exchanges would
be required to identify factors impacting independence which could
result in definitions that exceed those currently required under NYSE
and NASDAQ listing standards, such as whether the director derived any
income from the issuer through consulting or advisory fees or otherwise,
and whether the director is otherwise affiliated with the issuer or one
of its subsidiaries or affiliates. Depending on how such standards are
implemented, they may result in an “independent” director more closely
resembling an “outside” director as defined under Section 162(m) of the
federal income tax code. Compensation committee members would be
responsible for considering the independence of compensation
consultants, outside counsel and other advisors retained by the
committee, including the provision of other services provided to the
issuer, the advisor’s policies and procedures regarding conflicts of
interest, business and personal relationships, and stock ownership of
the issuer by the advisor. Finally, the retention of compensation
consultants would need to be disclosed, as would any conflicts of
interest raised by such inquiries and how they were addressed.
Differences in the Senate and House bills
- Compensation Clawbacks. In further response to shareholder
outcry over executive compensation, the Senate bill strengthens SOX
Section 304 to require the “clawback” of incentive-based executive
compensation, including stock options, in the event of an accounting
restatement due to material noncompliance with financial reporting
requirements even if no one, including the executive whose compensation
is at issue, engaged in misconduct. The provision would require the
clawback of amounts paid based on overstated results for the three years
preceding the restatement date. Compensation would be recalculated
according to the restated performance.
- Link Between Pay and Performance. The Senate bill
requires the SEC to amend Item 402 of Regulation S-K to require
disclosure of how executive compensation relates to financial
performance, taking into account changes in the value of stock and
dividends and any distributions. The SEC must also issue rules requiring
disclosure of how median employee compensation compares to CEO
compensation.
Proxy Access
Both bills amend Section 14(a) of the Securities Exchange Act of 1934
to provide for shareholder access to proxies to nominate directors. The
House bill requires, and the Senate bill authorizes, the SEC to
prescribe rules and regulations granting shareholders such access.
Senate backers and shareholder activists have pushed for proxy access
for years, arguing that it will help remedy a perceived lack of
management accountability. Under either provision, the SEC is likely to
enact rules for shareholder access. As has been widely reported, the SEC
issued a proxy access rulemaking proposal in 2009. After undergoing
extensive notice and comment, the proposal was held in abeyance pending
Congressional action clarifying the agency’s authority in this
area.
Majority Voting
The Senate bill requires that uncontested director elections be
determined by a majority vote. Incumbent directors receiving less than a
majority vote would be required to offer their resignation, which the
Board could accept or decline. The Board would be required to make its
reasoning public within thirty days. This provision reflects concerns by
activist shareholders that the plurality voting standard in place at
many public companies allows for the election of uncontested candidates
even if they receive only one “yes” vote. The Senate bill retains the
plurality standard for contested elections. The House bill does not have
a majority vote provision.
Separation of CEO and Chair
Under the Senate bill, within 180 days of enactment the SEC must
require companies to explain in proxy statements why the positions of
chairman and CEO are separate or combined. This provision reflects a
view among some shareholder advocates that “best practices” requires
separation of the roles of CEO and chair. Currently, Regulation S-K
requires companies to disclose their leadership structure and why they
believe the structure to be appropriate.
Securities Litigation
The final version of the Senate bill did not include an amendment,
introduced by Senator Arlen Specter and mirroring a provision included
in the House bill, that would have overturned the United States Supreme
Court’s decision in Stoneridge Investment v. Scientific-Atlanta (2008) and Central Bank N.A. v. First Interstate Bank N.A.
(1994), rejecting aiding and abetting liability under the federal
securities laws. Those decisions have shielded lawyers, accountants, and
other corporate advisors from aiding and abetting claims in shareholder
suits. Senator Specter’s May 18, 2010 defeat in the Pennsylvania
Democratic Senate primary makes the amendment’s reemergence in
conference negotiations less likely.
Foreign issuers will be watching the reconciliation process closely
to see if a provision in the House version survives that would expand
jurisdiction over “f-cubed” litigation. The House version provides
federal courts with jurisdiction over securities fraud actions involving
“conduct within the United States that constitutes significant steps in
furtherance of the violation, even if the securities transaction occurs
outside the United States and involves only foreign investors; or
conduct occurring outside the United States that has a foreseeable
substantial effect within the United States.” The bill, on its face,
extends jurisdiction only to actions brought by the SEC or the United
States, in contrast with the National Australia Bank decision
pending before the Supreme Court which involves private “f-cubed”
securities litigation brought by shareholder plaintiffs.
****
Reconciliation efforts between the House and Senate versions of the
Restoring American Financial Stability Act of 2010 will continue over
the next few weeks, but do not appear likely to prevent finalization of
the bill and its delivery to the President for signature. Importantly,
the corporate governance provisions of the bill reflect a continuing
trend toward federalization of state law governance issues, and
increasing oversight of “gatekeeper” rating services.
This alert was authored by Securities Litigation partners Beth
I.Z. Boland and Michael D. Blanchard, and associate Michael C. Moran.
For more information about the subject matter of this alert, please
contact any of the lawyers listed below:
Dale E. Barnes, Co-chair, Securities Litigation
dale.barnes@bingham.com, 415.393.2522
Jordan D. Hershman, Co-chair, Securities Litigation
jordan.hershman@bingham.com; 617.951.8455
Stephen D.Alexander, Partner, Securities Litigation Group
stephen.alexander@bingham.com; 213.680.6518
Beth I.Z. Boland, Partner, Securities Litigation Group
beth.boland@bingham.com, 617.951.8143
Michael D. Blanchard, Partner, Securities Litigation Group
michael.blanchard@bingham.com, 860.240.2945
Stephen D. Alexander, Partner, Securities Litigation Group
steven.alexander@bingham.com, 213.680.6518
Laurie A. Cerveny, Partner, Corporate, M&A and Securities
laura.cerveny@bingham.com, 617.951.8527
Michael P. O'Brien, Partner, Corporate, M&A and Securities
michael.obrien@bingham.com, 617.951.8302
Circular 230 Disclosure: Internal
Revenue Service regulations provide that, for the purpose of avoiding
certain penalties under the Internal Revenue Code, taxpayers may rely
only on opinions of counsel that meet specific requirements set forth in
the regulations, including a requirement that such opinions contain
extensive factual and legal discussion and analysis. Any tax advice that
may be contained herein does not constitute an opinion that meets the
requirements of the regulations. Any such tax advice therefore cannot be
used, and was not intended or written to be used, for the purpose of
avoiding any federal tax penalties that the Internal Revenue Service may
attempt to impose.
