Small Public Company Forum

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), enacted on July 21, 2010, imposed several new requirements on public companies relating to executive compensation and corporate governance.  Among other things, the Act requires public companies to hold several types of shareholder advisory votes on executive compensation, starting in 2011.  On October 18, 2010, the SEC issued proposed rules to implement these requirements of the Act and expressed its intent to adopt final rules sometime between January and March 2011.  Even though the SEC was authorized to exclude smaller companies or other categories of companies from the application of these requirements, the SEC declined to do so.  Therefore, the advisory vote requirements will apply to smaller reporting companies as well as larger companies, unless the SEC changes its approach before the rules become final.

The following is a brief summary of the new requirements, followed by some “Frequently Asked Questions” about the “frequency vote” in particular, together with some general considerations to weigh when deciding what frequency to recommend to shareholders in your proxy materials.

SUMMARY

Key provisions in the Act’s advisory-vote requirements, as interpreted by the proposed SEC rules:

• Say-on-Pay Vote:  Public companies must hold a non-binding shareholder vote on executive compensation (the “Say-on-Pay vote”) at the first annual meeting on or after January 21, 2011.  Pursuant to this vote, shareholders will be asked to approve the executive pay described in the proxy statement (including the compensation tables and any narrative disclosure in the proxy statement).  This vote must be held no less frequently than once every three years.
• Frequency Vote:  Also, at the first annual meeting on or after January 21, 2011, public companies must hold a separate non-binding vote (the “frequency vote”) in which shareholders will express their opinion on whether the Say-on-Pay vote should be held annually, biennially, or triennially.  The frequency vote must be held at least once every six years.  After their annual meetings, companies must disclose on Form 10-Q whether they will abide by the shareholders’ preference on frequency.
• Requirements Not Subject to Adoption of Final SEC Rules:  The above requirements to hold the Say-on-Pay vote and the frequency vote at the first annual meeting on or after January 21, 2011 are effective regardless of whether the final SEC rules have been adopted.
• Parachutes Disclosure and Say-on-Parachutes Vote:  The proxy materials to approve any merger, sale of assets or similar transaction must include enhanced disclosure of the “golden parachute” compensation to executives related to the transaction, including a table and narrative disclosure.  The proxy materials must also include a separate shareholder advisory vote on the parachute compensation (the “Say-on-Parachutes vote”), unless the enhanced disclosure was part of a prior Say-on-Pay vote and there are no new arrangements.  In contrast to the Say-on-Pay vote and the frequency vote, the parachutes disclosure and Say-on-Parachutes vote requirements are not effective until the final SEC rules go into effect.

Frequency Vote FAQs

What must be covered by the frequency vote?

The frequency vote, which some have called the “Say-When-On-Pay” vote, must allow shareholders to express their opinion on whether the Say-on-Pay vote should be held every one year (annual), two years (biennial) or three years (triennial).  Proposed SEC rules require that shareholders be offered four choices on the company’s proxy card – annual, biennial, triennial, or a vote to abstain.  The SEC has proposed an amendment to Rule 14a-4 to permit the form of proxy cards to conform to these four choices.  Currently, on any vote other than the election of directors, the rule requires three choices (for, against or abstain). However, the proposing release confirms that the SEC will not object if shareholders are offered the four choices on the proxy card in the frequency vote, even before Rule 14a-4 is amended.

What if we can’t accommodate a vote with four possible choices in 2011?

The SEC’s proposing release highlights a possible logistical problem with the frequency vote in the coming year.  The SEC acknowledges that Broadridge and other service providers may need to reprogram their systems before they can handle a vote with four choices.  As a transitional matter, the SEC has stated that until the final rules go into effect next year, it will not object if companies offer only three choices (annual, biennial or triennial), without offering an “abstain” alternative.  Broadridge recently said it would be ready to handle four choices for 2011 shareholders meetings.

How often does the frequency vote need to be taken?

Under the Act, the frequency vote must be held no less often than once every six years. 

Does the frequency vote have any binding effect?

The frequency vote is a non-binding advisory vote, similar to the Say-on-Pay vote.  However, in the proposed rules, the SEC has created consequences for companies that do not abide by the preference expressed by the shareholders.  In this regard, the rules will amend Form 10-K and 10-Q to require that a company disclose its decision on how frequently it will conduct the Say-on-Pay votes in light of the results of the shareholder frequency vote.  This disclosure will be required in the filing for the quarter in which the frequency vote occurred.  If the company does not adopt a policy consistent with the results of the shareholder frequency vote (determined on a plurality vote basis), then proposed amendments to Rule 14a-8 will allow shareholders to introduce their own proposals on the frequency of Say-on-Pay votes and the company would not be permitted to exclude any such proposals.

WHAT FREQUENCY TO RECOMMEND?

Many companies will take the position that a triennial vote is preferable because they will want to avoid the effort, expense and disruption of holding a Say-on-Pay vote every year or every two years.  Further, some commentators have favored a triennial vote because it can encourage shareholders to take a long-term (as opposed to a short-term) view of compensation matters, and many companies have long-term incentive compensation plans that include 3-to-5 year measurement periods.  A triennial vote would also provide companies and their compensation committees with the most time to thoughtfully react to the results of advisory Say-on-Pay votes.

Nevertheless, annual Say-on-Pay votes can have advantages in some cases, and companies should consider their current relationships with shareholders and other factors.  For example, annual Say-on-Pay votes would give shareholders a regular means of expressing disenchantment with the company’s pay practices without feeling as though they have to vote against individual directors, or against a resolution to authorize a new or expanded equity compensation plan.  In addition, an annual frequency vote may become routine and efficient and be viewed as “pro-shareholder.”

Companies should attempt to determine the preferences, if any, of their large shareholders.  Anecdotally, many shareholders prefer annual votes, and Institutional Shareholder Services (ISS) recently stated its position that it will support annual Say-on-Pay votes.  However, some institutional investors have expressed the view that a biennial vote or triennial vote would be preferable, so they are not forced to analyze every company’s proposal every year.

EXAMPLES

For a description of some examples of proxy statements that include the Say-on-Pay and frequency vote language, see my recent post from the ON Securities Blog.

Submitted by Martin R. Rosenbaum, Partner at Maslon Edelman Borman & Brand, LLP.