Final SEC Ruling Regarding Say on Pay Rules Released

On January 25, 2011, the Securities and Exchange Commission (“SEC”) released the final ruling on compliance with what has come to be known as the “Say on Pay” portion of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) after a brief period following the November 18, 2010 close on the comment period of the initial proposal released last October. The Say on Pay requirement was intended to assist shareholders in regards to having a say on executive compensation to conform to Section 951 of the Dodd-Frank Act. It also gives shareholders the ability to vote on executive compensation arrangements and provides for additional disclosure of so-called “golden parachute” arrangements in merger proxy statements.

From the ruling, the Say on Pay portion of the Dodd-Frank Act aimed to provide shareholders with the following:

• An advisory on executive compensation and an advisory vote on executive compensation and an advisory vote on the desired frequency of these votes
• An advisory note on compensation arrangements and understandings in connection with merger transactions, known as “golden parachute” arrangements
• Additional disclosure of “golden parachute” arrangements in merger proxy statements

Shareholder advisory votes on executive compensation

With the first annual shareholders’ meeting that takes place on or after January 21, 2011, shareholders of companies subject to the federal proxy rules would be allowed to cast a shareholders vote on the frequency of casting a “say on pay” vote at least every six years from the initial vote (“frequency vote”). Companies would also be required to provide disclosure on the results of the frequency vote. The shareholder vote would be non-binding, but could result in a scenario in which a clear message is sent to the board of directors that any executive compensation approvals not within expected ranges or seen as detrimental to the company may not be tolerated the next time the board of directors’ terms are up for renewal.

In addition, shareholders would also vote on the proposed executive compensation itself at least once every three years. The final ruling also notes that it would take a majority of votes, not the plurality previously mentioned in the proposal, to determine the choice preferred by the company’s shareholders. Additional disclosure in the proxy in the Compensation, Disclosure and Analysis section include whether the company took into account the results of the frequency vote, whether the votes are non-binding and when the next vote will occur.

Although the proposal included amendments to Forms 10-K, 10-Q and 8-K, the SEC has determined that only Form 8-K will be revised to require companies to disclose the outcome of their shareholder votes of their frequency vote. This was done in response to comments regarding concern over the required timing possibly not allowing sufficient time for the issuers to fully consider the vote results. The summary of the votes required to be shown on the Form 8-K would also need to show the number of abstentions.

Golden parachute rule changes

For companies that are undergoing merger, going private transactions or tender offers, additional disclosures of “golden parachute” arrangements to executives would also be required. These additional disclosures would include the aggregate total of all compensation and the conditions that would cause the compensation to be paid or payable to the executive. In the spirit of reporting all aggregate compensation, de minimis amounts also need to be included in the disclosure as well. In certain cases, a separate shareholder vote would be needed to approve the “golden parachute” arrangement.

The following highlighted additional disclosures regarding “golden parachute” arrangements, which would need to be presented in tabular form by aggregate dollar value, are outlined in the final ruling:

• Cash severance payments, including but not limited to payments of base salary, bonus, and pro-rated non-equity incentive compensation plan payments

• Accelerated vested stock awards or payments in cancellation of those stock awards

• Pension and nonqualified deferred compensation benefit enhancements

• Perquisites and other personal benefits or property, health care, welfare benefits and any tax reimbursements

In events where certain pay would be contingent on certain events, the company would still be expected to make reasonable estimates and also disclose the material assumptions underlying those estimates. The narrative portion of the disclosure would cover items such as the payment frequency and any other material factors in compensation agreements linked to “golden parachute” arrangements.

Temporary exemption for smaller reporting companies

All public companies, including smaller reporting companies, are now required to comply with the rules discussed above. However, smaller reporting companies have been granted a temporary exemption and are not required to hold say on pay and frequency votes until the first annual meeting occurring on or after January 21, 2013. This exemption period would allow the SEC to potentially consider whether scaled down requirements would be necessary for the smaller reporting companies. It also provides some time for smaller reporting companies to be able to observe how other companies implement the new rule. Smaller reporting companies are not exempt from the majority of the “golden parachute” disclosure rules should they undergo through a merger, going private transaction or tender offer.

Final Thoughts

It was only a matter of time that this ruling would be drawn up and finalized as soon as the Dodd-Frank Act became effective last year. Although it was Mary Schapiro’s last item in the SEC Open Items Meeting on January 25, 2011, these new requirements will certainly have an impact of making public companies, their boards and shareholders maintain balance between their ideas of expected acceptable executive compensation levels.