The 2010 annual report and proxy season has arrived. To help you prepare this year’s annual report on Form 10-K and proxy statement for your annual shareholders meeting, we have summarized key developments and considerations that you should keep in mind. There have been some changes for 2010, and this alert touches upon some of their high points. Please do not hesitate to call us if you have any questions.
Topics covered in this alert include:
- Filing Deadlines
- Enhanced Disclosure Requirements
- Company Leadership Structure and the Board’s Role in Risk Oversight
- Compensation and Risk Management
- Summary Compensation Table and Director Compensation Table
- Enhanced Officer, Director and Nominee Qualifications and Experience Disclosure
- Consideration of Director Diversity
- Disclosure Regarding Compensation Consultants
- Accelerated Disclosure of Shareholder Voting Results
- “Say on Pay” and Other Pending Legislation
- SEC Comments Regarding Executive Compensation Disclosure
- SEC Staff Guidance on Reg S-K Items
- Shareholder Proposals/Proxy Access
- RiskMetrics 2010 Voting Policies
- Broker Discretionary Voting in Director Elections
- NASDAQ Changes
- NYSE Changes
- Reminder About Potentially Overlooked Items
- Mandatory XBRL
- E-Proxy Rules
The filing deadlines for your company’s annual report on Form 10-K for 2009 and quarterly reports on Form 10-Q for 2010 depend on your company’s status as a large accelerated filer, accelerated filer, or other type of registrant:
|Class of Filer
on Form 10-K
|Quarterly Reports on Form 10-Q
|Large Accelerated Filer
(Public float of $700
million or more)
|60 days after FY end
||40 days after Q end
(Public float of $75 million or more, but less than $700 million)
|75 days after FY end
||40 days after Q end
|All Other Registrants
(Public float of less than
|90 days after FY end
||45 days after Q end
ENHANCED DISCLOSURE REQUIREMENTS
On December 16, 2009, the SEC adopted new rules mandating increased disclosure about a public company’s compensation, corporate governance and risk policies and practices. The new rules, effective February 28, 2010, apply to companies that have a class of equity securities subject to SEC proxy rules, including management investment companies registered under the Investment Company Act of 1940. The new rules do not apply to foreign private issuers.
On December 22, 2009, the SEC staff provided the following guidance on the effective date and implementation of these new rules:
- If the company’s fiscal year ends on or after December 20, 2009, the company’s Form 10-K and definitive proxy statement must comply with the new rules if filed on or after February 28, 2010. A preliminary proxy statement filed before February 28, 2010 must comply with the new rules if the company expects to file its definitive proxy statement on or after February 28, 2010.
- A company may voluntarily comply with the new rules, provided, that if the company complies with the Summary Compensation Table and Director Compensation Table amendments, the company must then comply with all amendments to Regulation S-K.
- A company with a fiscal year ending prior to December 20, 2009, need not comply with the amendments to Regulation S-K in registration statements filed prior to the company’s 2010 Form 10-K.
- A new registrant filing its first registration statement on or after December 20, 2009 must comply with the rule changes if the registration statement is to be declared effective on or after February 28, 2010.
- If a company holds its shareholder meeting on or after February 28, 2010, the results of any voting at that meeting must be disclosed on Form 8-K.
View the full text of SEC’s press release announcing the new rules.
View the full text of SEC’s guidance on disclosure transition.
The new rules require enhanced disclosure for reporting companies in the following areas:
Company Leadership Structure and the Board’s Role in Risk Oversight
Under the new rules, companies will be required to discuss the board's leadership structure and why the company believes the structure is appropriate given its specific characteristics or circumstances. In particular, companies must discuss whether and why the board has chosen to combine or separate the CEO and Chairman positions. If these positions are combined, the company must disclose whether it has a lead independent director and what specific role that director plays in the leadership of the board. The SEC release clarifies that this new disclosure focuses on board leadership, not management leadership. The SEC states in its release that these disclosures "are not intended to influence a company's decision regarding its board leadership structure."
Disclosure also will be required regarding the board's role in the oversight of risk, whether through the whole board, a risk committee or the audit committee. Companies will be required to disclose the extent of the board’s role in "risk oversight" of the company, such as how the board administers its oversight function and the effect that this has on the board’s leadership structure.
These disclosures apply to the company’s proxy and information statements filed on Schedules 14A and 14C. These disclosures also apply in the statements of additional information filed as part of certain registration statements.
Compensation and Risk Management
Under the new rules, to the extent that risks arising from a company's compensation policies and practices for its employees are "reasonably likely to have a material adverse effect" on the company, the company must provide a narrative disclosure about how these policies and practices relate to risk management practices and risk-taking incentives. The disclosures will cover policies and procedures for compensating all employees, including non-executive officers. This new disclosure will not be part of a company’s Compensation Discussion and Analysis (“CD&A”), but instead will appear in a new separate section pursuant to a new provision under Item 402 of Regulation S-K. The SEC notes, however, that a company’s CD&A may still need to discuss how compensation policies or decisions for named executive officers relate to risk. Companies meeting the definition of a "smaller reporting company" are not required to provide the new disclosure and no disclosure is required of any company unless the materiality threshold is met.
The SEC notes that the "reasonably likely to have a material adverse effect" standard is intended to parallel the disclosure threshold used in a company’s Management Discussion and Analysis, and that the addition of the term "adverse" is meant to make clear that the new rules do not require companies to disclose how material compensation policies and practices may help the company.
The SEC also notes that in circumstances where companies have effective mitigating controls, companies may conclude that their compensation policies and practices do not create risks that are reasonably likely to have a material adverse effect and therefore no disclosure will be required. Companies are not required to make any affirmative statement regarding the absence of a reasonable likelihood of a material adverse effect.
The new rules contain a non-exhaustive list of situations that may trigger disclosure if material. Examples include compensation policies and practices:
- At a business unit that carries a significant portion of the company’s risk profile;
- At a business unit that is uniquely structured compared to other business units;
- At a business unit that is significantly more profitable than other business units;
- At a business unit where compensation expenses are a significant percentage of the unit’s revenue; and
- That vary significantly from the overall risk and reward structure of the company, such as bonuses that are awarded upon accomplishment of a task, while the income and risk to the company from the task extend over a significantly longer period of time.
The new rules do not mandate any specific issues that a company must discuss, but the rules include a set of “illustrative examples” that a company should consider addressing. If a company determines that disclosure is required, the rules provide the following list of examples of issues that companies may need to address regarding their compensation policies and practices:
- The general design philosophy of the company’s compensation policies and practices for employees whose behavior would be most affected by the incentives established by the policies and practices as such policies and practices relate to or affect risk taking by those employees on behalf of the company and the manner of their implementation;
- The company’s risk assessment or incentive considerations, if any, in structuring its compensation policies and practices or in awarding and paying compensation;
- How the company’s compensation policies and practices relate to the realization of risks resulting from the actions of employees in both the short term and the long term, such as through policies requiring claw backs or imposing holding periods;
- The company’s policies regarding adjustments to its compensation policies and practices to address changes in its risk profile;
- Material adjustments the company has made to its compensation policies and practices as a result of changes in its risk profile; and
- The extent to which the company monitors its compensation policies and practices to determine whether its risk management objectives are being met with respect to incentivizing its employees.
Summary Compensation Table and Director Compensation Table
The new rules alter how a company reports stock and equity-based awards in the Summary Compensation Table and the Director Compensation Table. Instead of reporting the value of awards by reference to the annual accounting charge taken in the year, the new rules require companies to report the grant date fair value of the awards as compensation in the fiscal year of grant. For performance-based awards, the company must determine the fair value of the awards by considering the likelihood that the performance measures will be met and must also disclose the maximum value of any performance-based awards as a footnote to the table.
Because these rules apply to all entries in the compensation tables, companies will have to revisit the 2007 and 2008 awards made to the 2009 named executives included in the compensation tables to determine and report the fair value of the prior-year awards. The new rules do not require inclusion of new named executive officers based on recalculating salaries from prior years in accordance with the new rules.
Enhanced Officer, Director and Nominee Qualifications and Experience Disclosure
The new rules call for a number of amendments to Items 401 and 407 of Regulation S-K designed to expand corporate governance disclosure and enable investors to determine whether and why a director or director nominee is an appropriate choice for a particular company. The new rules also expand the disclosure of certain legal proceedings in which the executive officers, directors and nominees have been involved.
Director and Nominee Qualifications and Experience
Item 401 of Regulation S-K has been amended to require additional disclosures about directors or director nominees. Companies will now be required to include in their proxy statements a discussion of the specific experience, qualifications, attributes or skills that the board took into account in determining that the individual should serve as a director of the company. This disclosure will be required annually for all directors, whether or not up for reelection, and, if material, should cover more than the past five years, including information about a person’s particular areas of expertise or relevant qualifications. These new disclosures will be required in addition to the current requirements in Item 407(c)(2)(v) of Regulation S-K that companies briefly describe the business experience during the past five years for each director nominee and that companies discuss the minimum qualifications and specific qualities or skills that the nominating committee believes are necessary for one or more directors to possess.
Disclosure regarding any directorships held at public companies and registered investment companies at any time during the past five years also will be required, even if the director or nominee no longer serves on that board. It is believed that this additional disclosure will allow investors to better evaluate the relevance of a director’s or nominee’s past board experience, as well as professional or financial relationships that might pose potential conflicts of interest. The new rules do not require disclosure of the specific experience, qualifications or skills that qualify a person to serve as a committee member, nor do they specify the particular information that should be disclosed.
Under the new rules, the time period for which directors, director nominees and executive officers are required to disclose their involvement in certain legal proceedings is extended from five to ten years. Additionally, under an amended Item 401(f) of Regulation S-K, the legal proceedings covered under this disclosure will be expanded to include:
- Any judicial or administrative order, judgment, decree or finding relating to an alleged violation of mail or wire fraud or fraud in connection with any business entity;
- Any judicial or administrative proceedings based on violations of federal or state securities, commodities, financial institution or insurance laws and regulations; or
- Any sanction or order of any self-regulatory agency, registered entity or equivalent organization.
Disclosure regarding private civil litigation is not required.
These enhanced disclosures will apply to a company’s annual reports filed on Form 10-K, proxy and information statements filed on Schedules 14A and 14C, and certain registration statements.
Consideration of Director Diversity
The SEC adopted a rule requiring a company to disclose whether the nominating committee (or the board) has a policy with regard to the consideration of diversity in identifying director nominees. If the nominating committee has a diversity policy, the company must describe how the policy is implemented and the effectiveness of the policy. The SEC leaves companies to define “diversity” as they deem appropriate. Some companies may define it “expansively to include differences of viewpoint, professional experience, education, skill and other individual qualities and attributes that contribute to board heterogeneity, while others may focus on diversity concepts such as race, gender and national origin.” The new rule is now encompassed in Item 407(c) of Regulation S-K.
Disclosure Regarding Compensation Consultants
Currently, companies are required to describe the role compensation consultants play in determining executive and director compensation. Under the new rules, companies are required to make the following additional disclosures:
- If the board engages a compensation consultant and the fees paid to the consultant for non-executive compensation consulting services exceed $120,000, the company must disclose the aggregate fees paid to the consultant for executive compensation consulting services and the aggregate fees paid for other services provided by the consultant. The company must also disclose whether management recommended engagement of the consultant and whether the board approved the non-executive compensation consulting services.
- If the board does not engage a compensation consultant but the company receives executive compensation consulting services, and if fees paid for non-executive compensation consulting services exceed $120,000, the company must disclose the aggregate fees paid to the consultant for executive compensation consulting services and the aggregate fees paid for other services provided by the consultant.
Companies need not disclose fees paid to consultants working with management if the board has its own consultants. Additionally, disclosures related to compensation consultants are required only if compensation consultants provide executive compensation consulting services. For this purpose, the following do not constitute executive compensation consulting services:
- Services involving only broad-based plans that do not discriminate in favor of executive officers or directors and are generally available to all salaried employees of the company; and
- The provision of information that is not customized for the company, or is customized based on parameters that are not developed by the consultant (e.g. surveys).
Accelerated Disclosure of Shareholder Voting Results
Companies are currently required to report the results of any matter submitted to shareholder vote during the most recent fiscal quarter on the related Form 10-Q or Form 10-K. The SEC has eliminated this rule but now requires a company to disclose the results of a shareholder vote under new Item 5.07 of Form 8-K within four business days after the end of the meeting. If the results are disputed and the company does not know the final vote in order to timely file the results, the company must report the preliminary voting results within four days of the shareholder meeting and file an amended Form 8-K within four days after it determines the final vote.
“SAY-ON-PAY” AND OTHER PENDING LEGISLATION
There has been increasing public support for greater accountability for executive compensation. In 2009, shareholders from over 100 companies requested the right to vote on compensation paid to the company’s executives. These “say on pay” votes continue to gain momentum. The Emergency Economic Stabilization Act of 2008, mandated that recipients of Troubled Asset Relief Program (“TARP”) funds provided “say on pay” votes to shareholders – while TARP funds remain outstanding. Since then, a number of bills have been introduced into Congress that would require “say on pay” votes for all public companies.
Of the various proposed bills to impose an annual “say on pay” vote for all public companies, the leading proposal is the Corporate and Financial Institution Compensation Fairness Act of 2009 (HR3269). HR3269, introduced by Rep. Barney Frank and passed by the House of Representatives this summer, is based on the Treasury Department’s “say on pay” proposal.
If adopted, HR3269 would require public companies to provide shareholders with an annual advisory (non-binding) “say on pay” vote regarding the compensation disclosed in the CD&A and compensation tables. In addition, the bill would require public companies to provide shareholders with an advisory (non-binding) “say on pay” vote regarding golden parachute payments to executive officers in connection with extraordinary transactions, such as mergers.
In addition to “say on pay” proposals, more restrictive limits on executive pay have been proposed in various House and Senate bills, including specific caps on pay, “claw backs” of unearned incentive pay, prohibitions on severance paid for non-performance, and disclosure of pay disparity between the lowest and highest paid employees.
It is unlikely that any “say on pay” legislation, if enacted, would impact public companies until the 2011 proxy season, because the SEC would likely offer a 60-day comment period before finalizing regulations. HR3269, for example, would not generally take effect until the first annual meeting that is more than six months after the SEC issues final regulations.
However, even without enacted “say on pay” legislation, RiskMetrics Group addressed “say on pay” proposals in its proxy voting policies applicable to meetings of US companies held after February 1, 2010. RiskMetrics Group has stated that “say on pay” proposals, if available, will be the primary way for RiskMetrics Group to communicate its views on pay practices, rather than negative recommendations against the entire compensation committee. This policy is seen as a way to encourage companies to adopt “say on pay” by offering a pass, at least in the first round, for compensation committee members. RiskMetrics Group plans to evaluate “say on pay” proposals on a case-by-case basis, also considering a “pay for performance” factor which examines the alignment of the CEO’s total direct compensation and total shareholder return over a period of at least five years.
SEC COMMENTS REGARDING EXECUTIVE COMPENSATION DISCLOSURE
In November 2009, Shelley Parratt, Deputy Director of the SEC’s Division of Corporation Finance, detailed the agency’s observations regarding its 2009 review of executive compensation disclosures. Deputy Director Parratt’s speech focused on three areas: (1) analysis; (2) performance targets; and (3) what to expect from the comment process in 2010.
Despite improvement in the level of analysis that companies have provided in their executive compensation disclosures since 2007, the SEC continues to find a significant number of cases where companies describe in exhaustive detail the framework in which compensation decisions are made, rather than the basis for these decisions. A discussion of the company’s compensation framework can be useful, but any description of the framework should not obscure the explanation of what the compensation is designed to reward.
A company’s analysis of its compensation decisions should provide shareholders with meaningful insight into the company’s compensation policies and decisions, including the reasoning underlying those decisions and policies. It is not sufficient for a company to provide factual statements about the actions of the compensation committee, or to merely describe the tools and analyses that were employed in making compensation decisions. Rather, the company should describe how the committee used these tools to determine compensation amounts and structures, and why the committee reached its decisions. Where a company used qualitative factors to make compensation decisions, the SEC has asked that the company discuss those specific factors and “clearly lay out the way that qualitative inputs are ultimately translated into objective pay determinations.”
Generally. Deputy Director Parratt stressed that the first issue regarding performance targets and disclosure is for the company to determine whether corporate or individual performance targets are material to its compensation policies and decisions. Even where a performance target does not result in an actual payout, the target may be material if it nonetheless plays an important role in the way the company creates incentives for its management. If a company determines that certain performance targets are material, then it must specifically—and if applicable, quantitatively—disclose the targets, unless the disclosure would cause substantial competitive harm to the company.
Determining Competitive Harm. Companies may omit specific quantitative or qualitative performance-related targets, even if the targets are material to compensation policies and decisions, if the company can show that disclosure would likely cause competitive harm to the company. The standard for establishing competitive harm is: (i) the information is confidential, and (ii) disclosure of the information would likely “cause substantial harm to the competitive position of the person from whom the information was obtained.” To justify omission of material performance targets based on the likelihood of competitive harm, the company must engage in the same analysis as it would in the context of a formal confidential treatment request.
While some parties have voiced concerns that the SEC has applied a more rigorous competitive harm standard to compensatory arrangements than to material contracts, Deputy Director Parratt insisted that the SEC applies the same standard to both analyses. Based on an internal SEC review of competitive harm comments and responses, the SEC claims that, “where companies adequately explained the nexus between disclosure of the subject performance target and the potential for resulting competitive harm, [the SEC] accepted the response and agreed with the omission of the specific target.” Deputy Director Parratt also stressed that, when a company determines that it may omit a performance target because of the potential competitive harm it could cause, the company “must disclose, with meaningful specificity how difficult or likely it would be for the company or executive to achieve the undisclosed target.”
Expectations for the 2010 Proxy Season
Expanded CD&A. As discussed above under the heading “Enhanced Disclosure Requirements,” the SEC expanded CD&A disclosures to require companies to address the way that the company’s overall compensation policies may create incentives that can affect the company’s overall risk.
Stricter Review of Disclosures. As the SEC enters its fourth year of reviewing executive compensation disclosures under the current rules, its expectations regarding the quality of companies’ disclosures have been raised, and SEC comments will reflect this change. According to Deputy Director Parratt, “[A]ny company that waits until it receives staff comments to comply with the disclosure requirements should be prepared to amend its filings if it does not materially comply with the rules.”
Specifically, Deputy Director Parratt called out the following three ways that companies can improve their disclosures:
- Focus on making disclosures more meaningful and understandable. If a company explains its compensation decision-making process but does not explain why it made the compensation decisions it made, the SEC will request enhanced disclosure of the analysis.
- Provide detailed information regarding performance targets. When a company states that it determined a material element of compensation based on the achievement of performance targets, the SEC will ask for specific disclosure of the targets and actual achievement level against the targets (or a statement that disclosure of such information is likely to result in competitive harm).
- Provide names of peer group companies used for benchmarking. When a company refers to a peer group used for benchmarking purposes, the SEC will ask for the names of the peer group companies, how the company selected those peers, and where actual awards fell relative to the benchmark.
SEC STAFF GUIDANCE ON REG S-K ITEMS
Last year, the SEC staff updated its interpretative guidance on Regulation S-K to address a number of issues affecting companies’ proxy statement disclosures and annual reports. The comprehensive update replaced prior interpretive guidance on Regulation S-K and included updates to the following subsections:
- 301 – Selected Financial Data
Item 308 and 308T
- 308 – General
- 308T(a) – Management's Annual Report on Internal Control over Financial Reporting
- 402(a) – General
- 402(c) – Summary Compensation Table
- 402(d) – Grants of Plan-Based Awards Table
- 402(f) – Outstanding Equity Awards at Fiscal Year-End Table
- 402(i) – Nonqualified Defined Contribution and Other Nonqualified Deferred Compensation Plans
- 404 – Transactions with Related Persons, Promoters, and Certain Control Persons
- 507 – Selling Security Holders
View additional guidance.
SHAREHOLDER PROPOSALS/PROXY ACCESS
The continued effects of the global financial crisis and the state of the economy will likely lead to another active year for shareholder proposals by corporate governance activists. Proxy access continues to be a major issue and 2010 may bring a new SEC policy.
2009 Post-Season Review
RiskMetrics Group (“RMG”) reported that government intervention in the management and executive compensation of financial firms and other companies overshadowed the investor action in the 2009 proxy season. Nonetheless, the 2009 proxy season was active; a greater percentage of governance proposals went to vote, fewer were omitted after corporate challenges and fewer were withdrawn. RMG found that:
- Overall, 37% of governance proposals that go to vote receive majority support, up from 30% in 2008.
- 91 directors at 49 firms failed to receive majority support, almost three times as many as failed to do so in 2008. RMG attributes these Against votes to tax-gross ups and compensation practices at S&P 500 firms and adoption of poison pills without shareholder ratification at smaller firms.
- Shareholder “say on pay” proposals received majority support at 22 firms, double the number of firms as in 2008. According to RMG, there was an increase in mutual fund support for these resolutions.
- Shareholder resolutions seeking independent board chairs received 36% support, allowing for cumulative voting received 34% support, requiring a majority to elect directors received 58% support.
- There were 12 proposals for shareholder votes on “golden coffin” death benefits and hold-equity-through-retirement benefits, and there were 2 proposals for the establishment of bonus “banks,” in 2008 there had been none.
View the entire summary.
Exclusion of Shareholder Proposals on “Ordinary Business” Grounds
Under Rule 14a-8(i)(7), a company may exclude a proposal that relates to company’s ordinary business operations. On October 27, 2009, the SEC announced new analysis in its determination of whether to grant no-action relief to shareholder proposals on an “ordinary business” basis.
Previously, the SEC granted no-action requests from companies seeking to exclude shareholder proposals relating to environmental, financial or health risks. The SEC sought to determine whether the proposal related to the company engaging in an evaluation of risk, which it considered within the company’s ordinary business operations. In Staff Legal Bulletin No. 14E (“SLB 14E”), the SEC indicated that it was concerned that its previous view might have resulted in “unwarranted exclusion of proposals that relate to the evaluation of risk but that focus on significant policy issues.” The SEC will no longer focus on whether the proposal relates to an evaluation of risk, but will determine whether the subject matter raises significant policy issues and has a sufficient nexus to the company.
Under SLB 14E, the SEC will no longer allow companies to exclude proposals relating to CEO succession planning under the view that the proposals relate to the “termination, hiring or promotion of employees.” Now, the SEC takes the view that CEO succession planning raises a “significant policy issue regarding the governance of the corporation.”
View the full text of SLB 14E.
SEC to Address Proxy Access in 2010
Under Rule 14a-8, the current proxy system allows an issuer to exclude proposals relating to an election for membership on the company’s board of directors. If shareholders wish to nominate their own candidates for directors in opposition to the board’s nominees, they must prepare and pay for their own proxy statement and proxy card. “Proxy access” is the term used to refer to shareholder proposals that attempt to circumvent the current proxy system.
On December 14, 2009, the SEC re-opened the public comment period for its proposed rule on shareholder director nomination. Proposed Rule 14a-11 would establish a proxy access right to nominate directors with a sliding ownership threshold (from 1 to 5 percent) based on the size of the company. Proposed amendments to Rule 14a-8 would permit proxy access for shareholder proposals, unless such proposals would be excludable because they conflict with state law or proposed Rule 14a-11.
View the full text of the proposed rule.
Submit your comments.
Delaware Amendments on Proxy Access and Reimbursements
Effective August 1, 2009, Delaware companies have the option, but are not required to, adopt bylaws to permit shareholder access to the company’s proxy statement to nominate director candidates. Companies are allowed to impose lawful conditions on proxy access including, but not limited to: minimum record of stock ownership by the nominating shareholder; disclosure of certain information about the nominating shareholder and nominee including their stock ownership; condition the right on the number or proportion of nominees by the shareholder and whether the shareholder has previously sought such inclusion; disallowing nominations if the shareholder or its nominee has purchased or intends to purchase a certain percentage of the company’s voting shares within a specified time before the election; and requiring the nominating shareholder to indemnify the company for loss resulting from false or misleading statements made by the shareholder in the nomination.
Delaware companies are also permitted, but not required, to adopt bylaws to reimburse shareholders for their expenses incurred in soliciting proxies for director elections. A company can limit the right to reimbursement based on lawful conditions including, but not limited to: the number or proportion of directors nominated by the shareholder and whether the shareholder has previously sought reimbursement; limiting the amount based on the proportion of votes cast in favor of the nominee or on the amount spent by the company soliciting proxies; and limitations relating to cumulative voting.
View the text of the bill.
RISKMETRICS GROUP 2010 VOTING POLICIES
In November 2009, RMG issued its 2010 updates to its US Corporate Governance Policy. Among the most important changes were to its Executive Compensation and Poison Pill policies. RMG separately announced that it plans to revamp its governance rating service, currently known as “CGQ,” and will roll out the new service in 2010.
RMG will use Management Say on Pay (“MSOP”) proposals as the primary tool to address pay practices, but in absence of a MSOP proposal, it will continue to issue Against or Withhold recommendations for other proposals or directors.
Pay for Performance
RMG currently makes adverse vote recommendations if there is a “pay for performance disconnect” defined as an increase in CEO total compensation at a company whose one-year and three-year total shareholder returns are in the bottom half of their industry groups. In 2010, RMG will look at the alignment of CEO total compensation and total shareholder returns over one-year, three-years and five-years.
Problematic Pay Practices
The following practices, on their own, may result in (1) Against recommendation on MSOP proposals, (2) Against or Withhold recommendation for compensation committee members or the entire board or (3) Against recommendation for an equity-based incentive plan if it finds that it contributes significantly to pay-for-performance misalignment:
- Multi-year guarantees for salary raises, equity compensation and bonuses not tied to performance;
- Repricing or replacing of underwater stock options or stock appreciation rights without prior shareholder approval, including cash buyouts and voluntary surrender/subsequent re-grant of options;
- Including additional years of unworked service in pension calculation, without sufficient justification, resulting in significant benefit;
- Perquisites for former executives and extraordinary relocation benefits (including home buyouts) for current executives;
- Change-in-control (“CIC”) payments exceeding 3x base salary and target bonus; single-trigger CIC payments; new or materially amended agreements with modified single triggers (where an executive may voluntarily leave for any reason and still receive CIC package); new or materially amended agreements that provide for an excise tax gross-up, including modified gross-ups;
- Tax reimbursements for perquisites such as personal use of corporate aircraft, executive life insurance, bonuses, excise tax gross-ups, etc.;
- Dividends on unvested performance shares or units; or
- Executives using company stock for hedging activities, such as cashless collars, forward sales, equity swaps, etc.
Even where these stand-alone factors are not present, RMG will evaluate policies that it considers to incentivize excessive risk-taking and will consider a negative recommendation. These policies include guaranteed bonuses; single performance metric for short- and long-term plans; lucrative severance packages; high pay opportunities relative to industry peers; disproportionate supplemental pensions; or mega annual equity grants that provide unlimited upside with no downside risk. RMG will weigh these factors against mitigating factors such as rigorous claw-back provisions and robust stock ownership/holding guidelines.
RMG adopted a more nuanced approach to its recommendation for director votes when the board has adopted or renewed a poison pill plan without shareholder approval, and its recommendation for shareholder ratification of Net Operating Loss (“NOL”) poison pill plans.
The new policy distinguishes between short-term (≤ 12 months) and long term (>12 months) poison pills. RMG will continue to recommend an Against/Withhold vote on directors where the companies have adopted or approved a long-term plan without shareholder approval. The companies will be reviewed once every three years, but companies with classified boards will be reviewed annually. Where the company adopts a short-term poison pill, RMG will make a case-by-case recommendation on directors considering the following factors:
- Did the company have time to put the pill to shareholder vote given the circumstances?
- What was the company’s rationale?
- What are the company’s governance structures and practices?
- What is the company’s track record of accountability to shareholders?
RMG will recommend an Against/Withhold vote on directors where the company has made a material, adverse change to an existing poison pill without shareholder approval. Finally, RMG will make a case-by-case recommendation for NOL poison pill ratification considering the same factors it previously considered (the trigger, value of the NOLs, the term, shareholder protection mechanisms such as sunsets), but will now also consider the company’s existing governance structure, e.g. board independence, takeover defenses, history of responsiveness to shareholders, other problematic governance concerns.
RMG also made a number of minor changes to its voting policies. In 2010, RMG will:
- Apply its policies to publicly traded limited liability companies and limited partnerships;
- Utilize new calculations to measure volatility, average stock price and burn rate in making recommendations on equity plan proposals;
- Change its independence standards for directors, including the materiality test for transactional relationships and the services that it considers “professional;”
- Weigh new factors for proposals to increase the capital stock of a company;
- Change its approach to proposals on greenhouse gas reduction goals; and
- Make case-by-case recommendations for Chapter 11 reorganization plans.
For further details on these topics and the topics above, access the full 2010 U.S. Corporate Governance Policy Updates.
BROKER DISCRETIONARY VOTING IN DIRECTOR ELECTIONS
In July 2009, the NYSE amended its Rule 452 to classify the election of directors as a “non-routine” matter thereby preventing brokers from exercising their discretionary authority to vote undirected shares in the election. This rule change applies to shareholder meetings occurring after January 1, 2010 and affects public companies, regardless of whether they are listed on the NYSE.
Historically, brokers have utilized this discretionary power to vote shares that were held in the name of the broker on behalf of a beneficial owner who failed to provide voting instructions. Broker discretionary voting makes up a significant portion of the vote of most, if not all, companies. Because brokers currently vote a significant portion of the shares held by retail investors, companies with larger retail shareholder populations (i.e. mid to small cap companies) will more acutely feel the effects of the rule change.
The negative consequences of the rule change include the increased potential that companies with majority voting standards will have nominees who fail to receive enough votes to be elected, a rise in the level of influence of holders of a significant block of stock over the outcome of elections and greater difficulty achieving a quorum at a shareholder meeting.
Because of the potential consequences of this rule change, companies should assess the likely impact that the loss of broker discretionary voting will have on their annual elections. Part of this assessment requires understanding how many broker discretionary votes are typically cast in director elections for that company. If determinable, the difference between the number of votes cast in director elections and the number cast with respect to a “non-routine” matter from last year’s shareholder meeting provides a rough estimate for how many broker discretionary votes were cast.
Companies should also be prepared to mitigate the effects of this rule change. To do so, there are practical steps that a company can take, including the following:
- Include a routine item, such as the approval of auditors, in the company’s proxy statement so that the broker vote can be counted for purposes of determining a quorum.
- Ensure that the company’s proxy materials have clear and easily accessible instructions for voting.
- Prepare to conduct multiple mailings if the company needs the retail shareholder vote and consider the advisability of using the telephone voting services offered by proxy solicitation firms.
- Hire a proxy solicitor to assist with obtaining votes.
- Effective December 17, 2009, companies are required to submit material news announcements to the NASDAQ MarketWatch Department at least 10-minutes prior to public release. See SEC Release No. 34-61008. Access the electronic disclosure form.
- On July 31, 2009, NASDAQ announced that it would reinstate its bid price and market value continued listing requirements, effective August 3, 2009. See SEC Release No. 34-60374. NASDAQ modified the procedures for delisting a company that does not meet these requirements. See SEC Release No. 34-60611.
- The NASDAQ Listing Council solicited comments for corporate governance best practices, but has not proposed or adopted any rules. The best practices address independent directors meeting in executive session, limiting the number of outside boards on which a director may serve, shareholder voting on outside auditors, adopting advanced resignation requirement for directors who fail to receive a majority vote, developing a process to facilitate shareholder communication, requiring an independent board chair and eliminating staggered boards. The Listing Council is considering a “comply or disclose” model that would not make the best practices mandatory, but would require a company to adopt the best practices or disclose why they have not complied with the best practices in their annual report. View the Official Solicitation.
- As your company addresses issues raised in the current economy, there a number of NASDAQ rules to keep in mind:
- Unless an option plan specifically authorizes a re-pricing or option exchange, NASDAQ considers such an action to be a material amendment to the plan and requires shareholder approval.
- Subject to limited exceptions, NASDAQ rules require shareholder approval where the number of shares that a company may issue, in connection with a private placement or another transaction, equals 20% or more of the pre-transaction shares.
- An issuer is required to provide NASDAQ 15 days’ prior notice before increasing its total shares outstanding by 10% or more.
- The NYSE rule change eliminating broker non-votes in the election of directors is discussed above.
- On November 2, 2009, the NYSE extended a pilot program related to the delisting of companies. Prior to the pilot program, companies that qualified for listing on the NYSE were delisted if company’s average global market capitalization over a consecutive 30 trading-day period was less than $75 million and, at the same time, total stockholders' equity was less than $75 million. The pilot program lowered each of these thresholds to $50 million and has been extended through February 28, 2010. See SEC Release No. 34-60911.
- Companies listed on the NYSE that fall below the $1.00 listing standard now have additional methods to cure before being delisted. Previously, a company was entitled to a six month cure period that required the closing price for the stock on the last day of that six month period and the average trading price over the 30 day period ending on the last day of the six month period to exceed $1.00. The new rule, effective September 2, 2009, allows a company to cure if the closing price for the stock on the last day of any month during the six month period and the average trading price over the 30 day period ending on the last day of such month exceeds $1.00. See SEC Release No. 34-60612.
- On November 25, 2009, the SEC approved amendments to certain portions of the NYSE listed company manual related to corporate governance. Some of the highlights of the rule changes, effective January 1, 2009, include:
- Eliminating certain disclosures required in Section 303A that were similar to disclosures required by Item 407 of Regulation S-K and incorporating the similar Item 407 requirements directly into Section 303A;
- Requiring disclosure of a method by which all interested parties (and not just shareholders) can communicate concerns to the presiding director or to the non-management or independent directors as a group;
- Adding the requirement that companies include their web address in proxy statements and annual reports while removing the requirement that the company state that the documents posted on the website are available in print upon request;
- Requiring disclosure of a determination that service by any member of the company’s audit committee on the audit committee of more than three public companies will not impair the member's ability to serve effectively on its audit committee, regardless of whether the company has a policy in place limiting such service;
- Allowing companies to make on their website, disclosures otherwise required in their proxy statement or annual report related to contributions to tax exempt organizations, executive sessions of non-management or independent directors, how to communicate with the presiding director or the non-management or independent directors and simultaneous service of an audit committee member on more than three public companies;
- Eliminating the requirement to disclose the filing of the certificate related to corporate governance and public disclosure with the NYSE, which does not eliminate the requirement to file such certification;
- Allowing companies to hold regular executive sessions of independent directors as an alternative to sessions of non-management directors;
- Amending the requirement to disclose any waiver of the company’s code of business conduct and ethics granted to an executive or director to require such disclosure to be made within four days of the grant through a press release, website announcement or Form 8-K; and
- Requiring the CEO to notify the NYSE of any noncompliance with NYSE corporate governance listing standards.
REMINDER ABOUT POTENTIALLY OVERLOOKED ITEMS
While the following items are fairly basic (and none of them are new this year), they are, occasionally, overlooked by harried company personnel:
- Companies that pay executives performance-based compensation must consider whether or not the material terms of the performance goals must be disclosed and approved by their shareholders under Section 162(m) of the Internal Revenue Code of 1986, as amended. This code section requires, among other things, that if the compensation committee retains the discretion to change the targets for a performance goal, the material terms of the performance goals must be disclosed and re-approved by the shareholders at least once every five years.
- Although companies are not required to webcast their annual meetings, non-public information might be communicated during these sessions, raising Regulation FD (Fair Disclosure) concerns. Because webcasting information is one of the broad, non-exclusionary distribution methods the SEC accepts as complying with Regulation FD (assuming that an appropriate press release is issued in advance of the meeting), companies may want to consider setting up a webcast of their annual meeting to help prevent Regulation FD issues.
- All Form 10-Ks should be accompanied by a letter (correspondence file only) pursuant to Instruction D to Form 10-K, either indicating changes or confirming no changes in the company’s accounting policies.
- On the date that a company mails or first makes available its proxy materials to shareholders, it must furnish seven hard copies of the glossy annual report (or wrapper) to the SEC and, to the extent applicable, six copies of all proxy materials (including proxy card) to the NYSE or three copies of the glossy annual report (or wrapper) to the AMEX. A company that files its proxy statement and Form 10-K via EDGAR does not need to provide a hard copy of any materials, including its glossy annual report, to NASDAQ.
- If a company’s proxy statement contains an equity plan proposal, the proxy statement must be accompanied by a letter to the SEC (as an EDGAR correspondence item only), pursuant to Instruction 5 to Item 10 of Schedule 14A, stating when the shares issuable under the plan will be registered, presumably on a Form S-8 registration statement, under the Securities Act of 1933, as amended.
- A company should review material agreements that have been granted confidential treatment to confirm whether confidential treatment needs to be renewed or has expired.
- In the process of reviewing its exhibit list for its Form 10-K, a company should remove any agreements no longer required to be filed as material contracts and update the list to include any additional contracts filed with Form 8-Ks and Form 10-Qs throughout the year. Companies should also be thoughtful about their determination that an agreement is a material contract, since it sets precedent for the evaluation of future agreements and drives disclosure in Form 8-Ks, Form 10-Qs, and the Form 10-K.
- A company should incorporate any undertakings that it promised to the SEC in response to any comments letters it received in the past year.
The NYSE and AMEX require listed companies to file corporate governance certifications each calendar year. The annual certification is due no later than 30 days after the company’s annual shareholders’ meeting. NASDAQ requires an updated certification only if a change in the company’s status results in the prior certification to be no longer accurate.
eXtensible Business Reporting Language (“XBRL”) is a language used to communicate business and financial data. In June 2009, the SEC began the phase-in of XBRL, which is now mandatory for reports and certain other filings made with the SEC by large accelerated filers with a market capitalization exceeding $5 billion. The use of XBRL will become mandatory for large accelerated filers for reports due on or after June 15, 2010. The use of XBRL for remaining filers will become mandatory in 2011. Companies should assess when and how they will be required to implement XBRL.
The SEC’s E-Proxy rules mandating electronic availability of proxy materials to shareholders on a specified, publicly accessible website other than the SEC’s EDGAR website are in effect for all issuers commencing a solicitation of proxies, other than a solicitation in connection with merger or acquisition transactions.
Under the rules, an issuer may send proxy materials to shareholders via the “notice only” option, the “full set delivery” option, or a hybrid of the two. The hybrid option would allow, for example, “full set delivery” for retail investors and “notice only” for institutional investors.
Notice Only Option
Under the “notice only” option, a notice can be sent without a full set of proxy materials. Here, a “Notice of Internet Availability of Proxy Materials” must be sent out at least 40 days before the shareholder meeting date, and the proxy materials must be posted on a website, other than the SEC’s EDGAR site, on or before the date the notice is sent. A proxy card may not accompany the initial notice. Issuers should keep in mind that intermediaries will require advance delivery of materials to allow them to prepare materials and coordinate distribution to beneficial owners. The website must provide a shareholder with means to execute a proxy at the time notice is first sent to the shareholder. This website may provide, but does not require, an internet voting platform; as an alternative, the website may include a telephone number or a method to download and print a proxy card. Materials must be presented on the website in a format, or formats, convenient for searching, reading online, and printing on paper. The company may send a second notice 10 days or more after sending the initial notice that is accompanied by a proxy card.
Shareholders may request hard copies of proxy materials, in which case, the company must send a copy within three business days after receiving the request. Hard copies of the annual report must still be sent to the NYSE, AMEX and SEC. Companies are advised to pay close attention to the SEC rules regarding internet security and the contents of the notices and websites.
Full Set Delivery Option
Under the rules, all companies and other soliciting persons subject to the rules must post a complete set of proxy materials on a free website, other than EDGAR, that meets certain requirements, and send a notice to shareholders regarding availability. Therefore, companies using the “full set delivery” option follow the traditional method of mailing proxies, except that they must additionally send a “Notice of Internet Availability of Proxy Materials” or incorporate the required notice information into their proxy materials. Additionally, these issuers must post the proxy materials on the free website no later than the date the notice was first sent to shareholders; but these issuers are not subject to the 40-day advance notice requirement.
Issuers may also elect to use the “notice only option” with regard to some shareholders and the “full set delivery option” with regard to other shareholders. This allows issuers to “slice and dice” their shareholder base to address shareholder preferences, marketing concerns or other factors.
On October 14, 2009, the SEC published proposed amendments and a new rule aimed at increasing shareholder responses to proxy solicitations in connection with the “notice only” option under the “notice and access model.” As of the date of this report, the SEC has not adopted these proposals. The objectives of the proposals are to remove regulatory impediments that are believed to be reducing shareholder voting. The proposed amendments would increase flexibility in the format of the notice; and provide an extended timeframe for contestants to use the “notice only” option. A proposed new rule would permit issuers and contestants to include explanatory materials with the notice regarding the process of receiving and reviewing proxy materials and voting.
If you have any questions about the content of this alert, please contact a member of Oppenheimer’s Securities Team.
This alert is a copyrighted publication produced by Oppenheimer Wolff & Donnelly LLP. The information contained in this alert is of a general nature and is subject to change. Readers should not act without further inquiry and/or consultation with legal counsel.