November 11, 2009

Senator Dodd Releases Draft Financial Reform Bill

Yesterday, Senator Dodd (D-CT) released a draft of his massive – 1136 pages! – financial services reform bill. Among its numerous provisions, the “Restoring American Financial Stability Act of 2009” contains a half dozen or so provisions aimed at enhancing corporate governance and executive compensation practices. For those of you who aren’t inclined to wade through the bill text, here’s a summary of the bill’s key provisions – and here’s the press release from the Senate Banking Committee. We are posting memos regarding this bill in our “Regulatory Reform” Practice Area.

As noted by Mark Borges last nite in his “Proxy Disclosure Blog,” the executive compensation provisions are:

Advisory Vote on Executive Compensation (Section 951) – The bill would mandate an annual advisory vote on executive compensation (“Say on Pay”) for companies subject to the SEC’s proxy rules. The vote would apply to all shareholder meetings taking place one year after the bill’s enactment.

Advisory Vote on Golden Parachutes (Section 952)- The bill would mandate disclosure of and an advisory vote on any compensation arrangements to the CEO that would be payable on a merger or other acquisition transaction that had not been previously been subject to a “Say on Pay” vote. This vote would also go into effect one year after the bill’s enactment.

Compensation Committee Independence (Section 953) – The bill would require the SEC to direct the national stock exchanges to revise their listing standards to prohibit the listing of any company that did not maintain an independent compensation committee. In addition, the bill would direct the SEC to adopt rules ensuring that any compensation consultant, legal counsel, or other advisor to the compensation committee was “independent” (as defined by the Commission). The bill would ensure that the compensation committee had the authority to retain compensation consultants, legal counsel, and other advisors, require specific disclosure in the proxy statement of whether the committee had retained or received advice from a consultant and whether the consultant’s work raised any conflict of interest and how that conflict was addressed, and ensure that the committee had appropriate funding to retain these advisors. Finally, the SEC would be required to conduct a study on the use of compensation consultants

Executive Compensation Disclosure (Section 954) – The bill would require the SEC to amend Item 402 of Regulation S-K to require disclosure of information showing the relationship between executive compensation and the company’s financial performance and a pictorial comparison of the amount of executive compensation and the company’s financial performance over the preceding five years. This appears to be an apparent enhancement of the current Performance Graph.

Clawbacks (Section 955) – The bill would require companies to develop and implement a compensation recovery (“clawback”) policy that would (i) be triggered by a financial restatement, (ii) cover all executive officers, and (iii) require recovery of all incentive-based compensation (including stock options) from the executive officers (both current and former) for the three year period preceding the restatement in excess of what they would have been paid under the restatement.

Disclosure Regarding Employee Hedging (Section 956) – The bill would require the SEC to promulgate rules requiring proxy statement disclosure of whether a company permits its employees to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars, and exchange funds) that are designed to hedge or offset market declines affecting compensatory equity awards.

Compensation Standards for Holding Companies of Depository Institutions (Section 957) – The bill would require the new Financial Institution Regulatory Agency to establish standards prohibiting compensation plans of a bank holding company that provide executives, employees, director, and principal shareholders with excessive compensation or benefits, or could lead to a material financial loss to the bank holding company.

Higher Capital Charges (Section 958) – The bill would permit the appropriate federal banking agencies to impose higher capital standards for insured depository institutions with compensation practices that the agency determines pose a risk of harm to the institution.

Compensation Standards for Holding Companies of Depository Institutions (Section 959) – The bill would require the appropriate federal banking agencies to prohibit a depository institution holding company from paying excessive executive compensation or compensation that could lead to a material financial loss to any institution controlled by the holding company, or to the holding company itself.

Corporate Governance Provisions – A separate subtitle in the bill (Sections 971-974) would provide for several significant corporate governance changes, requiring:

– disclosure of whether a company has a single CEO/Chairman of the Board or has separated the CEO and Chairman positions;

– the annual election of all directors, thereby eliminating staggered boards;

– majority voting for all uncontested director elections; and

– proxy access for shareholders (with the SEC to promulgate rules governing this access right).

Note that the video archives are now both available for yesterday’s “6th Annual Executive Compensation Conference” as well as Monday’s “4th Annual Proxy Disclosure Conference.” If you missed registering, it’s not too late to catch-up and watch these videos now.

More Details about HealthSouth’s “Proxy Access Reimbursement” Bylaw

Last week, HealthSouth filed its Form 10-Q with the SEC and the company’s amended and restated by-laws are attached as Exhibit 3.3. As I blogged recently, HealthSouth just became the first company to adopt a “proxy access reimbursement” by-law and this new provision is reflected in Section 3.4(c) of the company’s revised by-laws.

Section 3.4(c) is complex and subject to several conditions and limitations. Reimbursement is not required if the Board “determines that any such reimbursement is not in the best interests of the Corporation or would result in a breach of the fiduciary duties of the Board of Directors to the Corporation and its stockholders or that making such a payment would render the Corporation insolvent or cause it to breach a material obligation incurred without reference to the obligations imposed by this Section 3.4(c).”

Reimbursement only applies if: (i) the stockholder’s nominee receives at least 40% of the total votes cast’ and (ii) fewer than 30% of the Directors to be elected are contested. The nominating stockholder (or group of stockholders) can only nominate one person for director at the annual meeting. Where the nominee is not elected, reimbursement is limited to the proportion of total expenses equal to the proportion of favorable votes received; if elected all expenses (as defined in the By-Laws) are reimbursed. There are a number of other conditions. Thanks to Mike Holliday for doing the sleuthing on this!

Check out #5265 in our “Q&A Forum” about whether a Delaware corporation must have a bylaw authorizing payment of proxy expenses. In other words, can Delaware law mandate reimbursement in the absence of a bylaw?

Ideas to Improve the Proxy Plumbing

Ahead of the SEC’s release of a concept release on fixing the proxy plumbing, a few groups have already submitted ideas to the SEC. For example, The Altman Group submitted a proposal to the SEC entitled “Practical Solutions To Improve the Proxy Voting System.” Their proposal focuses mainly on these five fixes:

1. A new methodology called ABO (i.e., All Beneficial Owners) should replace the current NOBO/OBO mechanism which has existed for 25 years, at least with regard to record dates for annual or special meetings.

2. The SEC should seek to authorize the establishment of a second mail and tabulation methodology, one that would give companies the ability (using the names available under ABO) to choose a different vendor to take responsibility for the mailing and tabulation process, while retaining the option to use the current Broadridge system. This new option would be akin to the way most companies currently use their transfer agent to mail and tabulate the votes of registered owners.

3. The SEC should require the NYSE to implement as quickly as possible a robust investor education program to try and ameliorate at least some of the impact resulting from the loss of broker voting on non-contested director elections under Amended NYSE Rule 452.

4. The SEC should amend Rule 13(f) so that information reported by institutions reflects both shares owned and also voting rights after taking into account loans and other transactions that alter such rights. We also suggest shortening the reporting period for 13(f) information to 15 days from 45 days after the end of a calendar quarter and reducing from 20 to 10 business days the pre-notification of a company’s annual meeting record date.

5. The SEC should establish new procedures to deal with issues like “empty voting” and the use of derivative positions to alter voting rights.

On, Jim McRitchie has posted his analysis of the differences between The Altman Group’s ideas and the positions of the Shareholder Communications Coalition.

– Broc Romanek