Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

The proposed rules on say-on-pay under Section 951 of the Dodd-Frank Act permit issuers to include an optional advisory vote on golden parachute arrangements in proxy statements for annual meetings.  The advantage of doing so is that in certain circumstances the issuer will not have to include an optional advisory vote on the golden parachute arrangements in connection with a subsequent acquisition, as required by the Dodd-Frank Act, if the parachute arrangements were previously approved in connection with an annual meeting.  The question remains whether issuers should elect such an option.  There are no hard and fast answers here, just advantages and disadvantages to weigh, and we have difficulty identifying decisive advantages.

For starters, unless the SEC finalizes the proposed rules in time to prepare your proxy statement, there seems to be little benefit in including the optional advisory vote.  The SEC could amend the rules before going final, and nothing would be accomplished.

It may make little sense to include an optional advisory vote on golden parachutes unless the issuer intends to include an annual advisory vote on other executive compensation.  The reason is if golden parachutes arrangements have changed since they were approved, the new items are still subject to an advisory vote in connection with the subsequent acquisition under proposed Instruction 6 to Item 402(t)(2) to Regulation S-K.  So little may have been accomplished.  There is the added risk that if the changes are immaterial they will be blown out of proportion by the fact that they are put to a separate vote.

In addition, the SEC could challenge a disclosure of the golden parachute arrangements in a routine review.  The end result may be the issuer has to agree that the disclosure might not have complied with the rule and therefore include the optional advisory vote upon a subsequent acquisition.

Even with an annual advisory vote, there are other considerations.  Golden parachute arrangements may change during the course of a year, meaning in any event new or changed items will have to be put to a vote in connection with an acquisition.  Its unclear (at least to us) when a change in base salary that affects severance pay would be considered a revision that would require a new vote.  The release implies any options granted that vest upon a change of control would be another new item.  It is unclear to us whether vesting of options, that would previously have vested upon a change of control, would be considered a new item.  Such vesting would certainly change the tabular disclosure required by proposed Item 402(t).

And the disclosure will not be easy to prepare.  The proposed rules require tabular disclosure of the parachute arrangements, with extensive explanations, and like the other compensation-related tables, numerous interpretive and computational difficulties may be encountered.  In addition, under Item 402(b)(ii), as presently written, issuers generally need not make disclosures of group life, health, hospitalization or medical reimbursement plans that do not discriminate in scope terms or operation, in favor of executive officers or directors of the registrant that are generally available to all salaried employees.  However, that will not be the case with respect to the disclosures required by proposed Item 402(t).  One might question if those non-discriminatory items relate to an acquisition but it will be more minutia to be considered.

Finally, issuers should consider whether an advisory vote on golden parachute matters will pass if included in a proxy statement for an annual meeting. ISS’s draft policies for comment on golden parachute arrangements provide “Features that may lead to a recommendation against include:

  • Recently adopted or amended agreements that include excise tax gross-up provisions (since prior annual meeting)
  • Recently adopted or amended agreements that include modified single trigger agreements (since prior annual meeting)
  • Single trigger payments that will happen immediately upon a change in control, including cash payment and such items as the acceleration of performance-based equity despite the failure to achieve performance measures
  • Single-trigger vesting of equity based on a definition of change in control that requires only shareholder approval of the transaction (rather than consummation)
  • Potentially excessive severance payments
  • Recent amendments or other changes that may make packages so attractive as to influence merger agreements that may not be in the best interests of shareholders
  • In the case of a substantial gross-up from pre-existing/grandfathered contract: what triggered the gross-up (i.e. option mega-grants at low point in stock price, unusual or outsized payments in cash or equity made or negotiated prior to the merger)
  • The company’s assertion that a proposed transaction is conditioned on shareholder approval of the golden parachute advisory vote.  ISS would view this as problematic from a corporate governance perspective.”

Even if you are not a big fan of ISS, common sense indicates that many of the items would be disfavored by investors and impair passage of an optional advisory vote on golden parachutes.  As a result, issuers should compare their golden parachute arrangements to the above list to assess likelihood of passage of an optional advisory vote.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

Section 951 of the Dodd-Frank Act requires advisory say-on-pay votes from shareholders on the compensation of named executive officers, the Compensation Discussion and Analysis, compensation tables and the other narrative disclosures required by Item 402 of Regulation S-K at least every three years.  We first covered the major points of Section 951 in detail here.  The say-on-pay vote is not binding on an issuer or its board of directors, although it is expected that proxy advisors will recommend withholding votes for the re-election of Compensation Committee members or board members of issuers that fail to make changes to executive compensation after a negative say-on-pay vote.  While the say-on-pay vote must occur at least every three years, it may occur annually or biennially.   The frequency of the say-on-pay vote will be determined by an initial shareholder vote (although the SEC interprets this as a non-binding vote), and a subsequent shareholder vote on say-on-pay frequency must be held at least once every six years.

The proxy card for the shareholder vote on the frequency of say-on-pay must include four choices: annual voting, biennial voting, triennial voting, and abstain.  The board of directors may, but is not required to, make a  recommendation to shareholders regarding the frequency of the say-on-pay vote.  As proxy season approaches, issuers should be considering which frequency they will recommend to their shareholders, or if they will make a recommendation at all.  

We expect board say-on-pay frequency recommendations will be driven by a number of factors.  The recommendations of companies perceived by issuers to be peer companies will be significant, as no issuer will want to appear as an outlier.  As usual, boards will likely give consideration to the preferences of shareholders that control significant voting blocks and have the power to affect change outside of the non-binding say-on-pay context.  Boards may feel that their compensation structure is better suited to a particular frequency for say-on-pay voting– for example, perhaps boards will want to match the frequency of the say-on-pay vote to incentive performance cycles.  In addition, the history of shareholder relations on executive compensation issues will likely be very important, as companies that have faced harsh criticism from shareholders or public scandal related to executive compensation may be inclined to recommend the annual say-on-pay vote, which provides shareholders with the most transparency and the opportunity to provide direct feedback. 

In addition to the general considerations mentioned above, boards should consider the following points when deciding on the frequency that they will recommend.

Annual Voting

  • Institutional Shareholder Services (ISS) has indicated that it will likely recommend annual say-on-pay votes, and a number of institutional shareholders may prefer the annual frequency for similar reasons
  • annual voting prevents issuers from playing it safe in voting years, saving unpopular or controversial decisions for years in which the shareholders won’t have a chance to express their dissatisfaction in a vote
  • annual say-on-pay voting aligns shareholder feedback with management decision making – if compensation decisions are made on an annual basis, then it makes sense for say-on-pay to occur annually
  • some issuers may treat an annual say-on-pay vote as a blocker that provides an outlet for shareholder dissatisfaction and prevents shareholders from expressing that dissatisfaction through negative votes for compensation committee members or negative votes on compensation components that require shareholder approval, such as an equity plan
  • there is speculation that if say-on-pay votes are solicited every year, then perhaps shareholders will come to regard them as routine items that warrant automatic approval, akin to auditor approvals

Biennial Voting

  • it has been suggested that the boards of most issuers will recommend either annual or triennial voting, as biennial voting dilutes the advantages presented by annual voting and by triennial voting
  • biennial voting may nevertheless be the right choice for some issuers based on their specific circumstances
  • there is a possibility that shareholders presented with three frequencies and wary of the board’s recommendation may default to biennial voting in the absence of strong feelings towards annual or triennial voting

Triennial Voting

  • triennial voting minimizes the administrative burden and expense of administering the say-on-pay voting, as compared to biennial or annual voting
  • as opposed to looking at a single year’s compensation decisions in isolation, a three year span allows the compensation policies to be contextualized in a way that may lessen negative perceptions held by shareholders
  • triennial voting may be a good match for companies that use multi-year time horizons for performance incentives
  • institutional shareholders may favor triennial voting because it reduces the frequency with which they must devote time and attention to their investment

Check back at Dodd-Frank.com frequently for the latest news and analysis regarding the implementation of the Dodd-Frank Act.

The Federal Reserve Board has established the Office of Financial Stability Policy and Research and appointed Board economist J. Nellie Liang as its director.

 The office is expected to bring together economists, banking supervisors, markets experts, and others in the Federal Reserve who will be dedicated to supporting the Board’s financial stability responsibilities.  The office will develop and coordinate staff efforts to identify and analyze potential risks to the financial system and the broader economy, including through the monitoring of asset prices, leverage, financial flows, and other market risk indicators; follow developments at key institutions; and analyze policies to promote financial stability.  It will also support the supervision of large financial institutions and the Board’s participation on the Financial Stability Oversight Council.

The financial stability team is expected to play an important role in implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act, in the Board’s oversight of systemically important financial institutions, and in the Board’s overall surveillance of the financial markets and the economy.

 Liang joined the Board in 1986, acting most recently as a senior associate director in the Division of Research and Statistics.  In that role, she has led a group of economists focused on the intersection of economics and finance, including oversight of capital markets, financial institutions, consumer finance, and financial flows.  Liang was a key participant in crafting the Federal Reserve’s response to the financial crisis and helped lead the Supervisory Capital Assessment Program, or bank stress tests, which helped increase public confidence in the banking system in 2009. Liang has a Ph.D. in economics from the University of Maryland and an undergraduate degree in economics from the University of Notre Dame.

 Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The SEC has proposed a new rule to help prevent fraud, manipulation, and deception in connection with security-based swaps.

 The rule is proposed under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which generally authorizes the SEC to regulate security-based swaps. The proposal would ensure that market conduct in connection with the offer, purchase or sale of any security-based swap is subject to the same general anti-fraud provisions that apply to all securities.  And it also would explicitly reach misconduct in connection with ongoing payments and deliveries under a security-based swap.

 The SEC’s rule proposal recognizes that security-based swaps are unlike other securities because they are typically characterized by ongoing payments or deliveries between the parties throughout the life of the swap.  Therefore, it is possible that one party may engage in misconduct to trigger, avoid, or affect the value of such ongoing payments.  Such fraud may occur separately from the sale, purchase, or offering.

 The proposed antifraud rule would apply not only to offers, purchases and sales of security-based swaps, but also explicitly to the cash flows, payments, deliveries, and other ongoing obligations and rights that are specific to security-based swaps. The rule would make explicit the liability of persons that engage in misconduct to trigger, avoid, or affect the value of such ongoing payments or deliveries.

 Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The SEC has published its proposed whistleblower rules, complete with almost 30 pages of forms for whistleblowers to use.   Employers (and let’s not forget that this applies to all employers, public and private) have rightly been concerned about the provisions of Section 21F of the Securities Exchange Act, as set forth in Section 922 of the Dodd-Frank Act.  The concern is employees will run to the SEC to report violations instead of advising the employer of the misconduct and permitting the employer to take appropriate action.  It appears the proposed rules only permit an employer to cut off a whistleblower claim if the employer self reports the violation.  And employees who have engaged in wrongful misconduct can collect a whistleblower award so long as they were not convicted of a related crime.

 Claims Are Difficult After the SEC Requests Information from an Employer

 While it is not my intention to analyze in detail every page of the 181 page release, a few points merit close examination.  A good feature of the proposed rules is once the SEC commences an investigation, it is difficult for an employee to be considered a whistleblower.  A whistleblower must do more than merely provide the SEC with information that is not compelled by subpoena or by other applicable law.  Rather, the whistleblower or his representative (such as an attorney) must come forward with the information before receiving any formal or informal request, inquiry, or demand from the SEC staff or from any other authority described in the proposed rule about a matter to which the whistleblower’s information is relevant.  A request, inquiry, or demand that is directed to an employer is also considered to be directed to employees who possess the documents or other information that is within the scope of the request to the employer.  Accordingly, a subsequent whistleblower submission from any such employee will not be considered “voluntary” for purposes of the rule, and the employee will not be eligible for award consideration, unless the employer fails to provide the employee’s documents or information to the requesting authority in a timely manner. 

 Other provisions of the proposed rules also make it more difficult to collect a whistleblower award if the SEC has already opened an investigation, even if the SEC has not already requested information from the employer.

 Compliance Counts, But Only if You Report What Your Learn to the SEC

 To be eligible for a whistleblower claim, the information supplied to the SEC must be derived from an individuals “independent knowledge” or “independent analysis.”  However, there is an exclusion from the proposed definition of those terms for information that is obtained from or through an entity’s legal, compliance, audit, or similar functions or processes for identifying, reporting, and addressing potential non-compliance with applicable law.  However, the exclusion ceases to be applicable, with the result that an individual may be deemed to have “independent knowledge,” and therefore may become a whistleblower, if the entity does not disclose the information to the SEC within a reasonable time or if the entity proceeds in bad faith.

 There is another curious part of the proposal where I have trouble connecting the dots.  If all the conditions of the rule are met, the SEC must pay the whistleblower an amount between 10% and 30% of monetary sanctions collected.  The proposal states the SEC will consider “higher percentage awards for whistleblowers who first report violations through their compliance programs.”  This seems like an incentive for a whistleblower to both report a matter through a compliance process and then immediately to the SEC.  But no relief appears to be given to employer that effectively addresses a violation it learns of through a compliance program but does not report the matter to the SEC.

 It Will be Difficult for Attorneys, Auditors, Supervisors and Compliance Officers to Make Whistleblower Claims

 There are several other exclusions from the definitions of “independent knowledge” or “independent analysis.”  First, it will be difficult for an attorney to make a whistleblower claim.  One exclusion, subject to some exceptions, is for information that was obtained through a communication that is subject to the attorney-client privilege.  Another exclusion applies when a would-be whistleblower obtains information as a result of the legal representation of a client on whose behalf the whistleblower’s services, or the services of the whistleblower’s employer or firm, have been retained, and the person seeks to make a whistleblower submission for his or her own benefit.   This exclusion would, for example, preclude an attorney from using information obtained in connection with the attorney’s representation of a client to make a whistleblower submission for the attorney’s own benefit.  This exclusion would not be limited to information obtained through privileged communications, but would instead extend to any information obtained by the attorney in the course and as a result of representation of the client.

 Likewise, there is an exclusion that applies to persons who obtain information through the performance of an engagement required under the securities laws by an independent public accountant, if that information relates to a violation by the engagement client or the client’s directors, officers or other employers.

 Another exclusion operates when a person with legal, compliance, audit, supervisory, or governance responsibilities for an entity receives information about potential violations, and the information was communicated to the person with the reasonable expectation that the person would take appropriate steps to cause the entity to respond to the violation.  As discussed above, the exclusion ceases to operate if the entity does not disclose the information to the SEC within a reasonable time or if the entity proceeds in bad faith.

 The SEC May Make Awards to Individuals Participating in Misconduct

 Proposed Rule 21F-14 provides notice that the provisions of Section 21F of the Exchange Act do not provide amnesty to individuals who provide information to the SEC relating to a violation of the securities laws. However, some whistleblowers who provide original information that significantly aids in detecting and prosecuting sophisticated securities fraud schemes may themselves be participants in the scheme who could be subject to SEC enforcement actions.   These individuals will not be immune from prosecution. Rather, the SEC will analyze the unique facts and circumstances of each case in accordance with its current policies to determine whether, how much, and in what manner to credit cooperation by whistleblowers who have participated in misconduct.  However, awards will not be made to persons who are convicted of a criminal violation related to the SEC action or certain other matters for which the whistleblower may be otherwise entitled to receive an award.

 A Warning for Employers

 Proposed Rule 21F-16(a) provides that no person may take any action to impede a whistleblower from communicating directly with the SEC staff about a potential securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement. The SEC believes the Congressional purpose underlying Section 21F of the Exchange Act is to encourage whistleblowers to report potential violations of the securities laws by providing financial incentives, prohibiting employment-related retaliation, and providing various confidentiality guarantees.  Efforts to impede a whistleblower’s direct communications with SEC staff about a potential securities law violation, however, would appear to conflict with this purpose.

 The SEC Can Communicate With Your Whistleblower Employees without the Consent of Your Lawyer

 Proposed Rule 21F-16(b) would clarify the SEC staff’s authority to communicate directly with whistleblowers who are directors, officers, members, agents, or employees of an entity that has counsel, and who have initiated communication with the SEC related to a potential securities law violation.  The proposed rule would make clear that the staff is authorized to communicate directly with these individuals without first seeking the consent of the entity’s counsel.

 Next, the CFTC

 The CFTC will propose its whistleblower rules on November 10, 2010.

 Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The CFTC will hold a public meeting on Wednesday, November 10, 2010, to consider the issuance of the following proposed rulemakings under the Dodd-Frank Wall Street Reform and Consumer Protection Act:

  •  Registration of Foreign Boards of Trade;
  • Registration of swap dealers and major swap participants;
  • Implementation of the Whistleblower provisions of Section 23 of the Commodity Exchange Act;
  • Establishing and governing the duties of swap dealers and major swap participants;
  • Implementation of conflict-of-interest policies and procedures by futures commission merchants, introducing brokers, swap dealers and major swap participants; and
  • Designation of a chief compliance officer, required compliance policies and annual reports of futures commission merchant, swap dealers and major swap participants.

 Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

In connection with the SEC’s proposed rulemaking requiring public companies to hold say-on-pay votes as required by the Dodd-Frank Act, the SEC has also proposed rules which will require institutional investment managers to annually report their votes cast on say-on-pay and other matters.  The proposed rules implement Section 951 of the Dodd-Frank Act which is codified in Section 14A(d) of the Exchange Act.

The proposed rules would require institutional investment managers that are required to file reports under Section 13(f) of the Exchange Act to file their record of Section 14A Votes with the SEC annually on Form N-PX.  The Exchange Act defines the term “institutional investment manager” to include “any person, other than a natural person, investing in or buying and selling securities for its own account, and any person exercising investment discretion with respect to the account of any other person.”  An institutional investment manager is required to file reports under Section 13(f) of the Exchange Act if the institutional investment manager exercises investment discretion with respect to accounts holding certain securities having an aggregate fair market value on the last trading day of any month of any calendar year of at least $100 million.

An institutional investment manager required to report on Form N-PX  would include in the report the manager’s record for each shareholder vote pursuant to Sections 14A(a) and (b) of the Exchange Act, i.e., Section 14A Votes.  The proposal would require  institutional investment managers to report their Section 14A Votes annually on Form N-PX not later than August 31 of each year, for the most recent twelve-month period ended June 30.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The Commodity Exchange Act, or CEA, as amended by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, permits the Secretary of the Treasury to issue a written determination exempting foreign exchange swaps, foreign exchange forwards, or both, from the definition of a “swap” under the CEA.  To date, the Secretary has not made any determination on whether an exemption is warranted.  Although not required under the Dodd-Frank Act, the Department of the Treasury is inviting comment on whether such an exemption for foreign exchange swaps, foreign exchange forwards, or both, is warranted and on the application of the factors that the Secretary must consider in making a determination regarding these instruments.

 In making the determination whether to exempt foreign exchange swaps and/or foreign exchange forwards,  the Secretary of the Treasury must consider the following factors:

  • Whether the required trading and clearing of foreign exchange swaps and foreign exchange forwards would create systemic risk, lower transparency, or threaten the financial stability of the United States;
  • Whether foreign exchange swaps and foreign exchange forwards are already subject to a regulatory scheme that is materially comparable to that established by the CEA for other classes of swaps;
  • The extent to which bank regulators of participants in the foreign exchange market provide adequate supervision, including capital and margin requirements;
  • The extent of adequate payment and settlement systems; and
  • The use of a potential exemption of foreign exchange swaps and foreign exchange forwards to evade otherwise applicable regulatory requirements.

 Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

In remarks before the Institute of International Bankers on October 21, 2010, CFTC Chairman Gary Gensler addressed the question on whether a foreign bank can be regulated in the U.S. as a swap dealer when dealing with US counterparties.  According to Mr. Gensler, the answer is “Yes.”   Mr. Gensler stated the Dodd-Frank Act provides that if an entity’s swap activities have “a direct and significant connection with the activities in, or effect on, commerce in the United States,” then the CFTC has jurisdiction. According to Mr. Gensler, the statute also gives the CFTC broad authority to “prevent the evasion of any provision” of the Dodd-Frank Act.  

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

ISS announced the opening of its annual comment period for its 2011 proxy voting policies. The comment period, part of ISS’ policy development process, offers institutional investors, corporate issuers, and industry constituents the opportunity to provide feedback on ISS draft policy updates.

Under the SEC’s proposed say-on-pay rules under the Dodd-Frank Act, public companies will be required to include a non-binding advisory vote on whether a company should include an advisory say-on-pay proposal every one, two or three years. The ISS draft policy update states “ISS expects to recommend for the annual vote.”  ISS’ rational is as follows: “ISS supports an annual [management say-on-pay proposal, or MSOP] for many of the same reasons it supports annual director elections rather than a classified board structure: because it provides the highest level of accountability and direct communication by enabling the MSOP vote to correspond to the information presented in the accompanying proxy statement for the annual shareholders’ meeting. Having MSOP votes only every two or three years, potentially covering all actions occurring between the votes, would make it difficult to create meaningful and coherent communication that the votes are intended to provide.  Under triennial elections companies, for example, a company would not know whether the shareholder vote references the compensation year being reported or a previous year, making it more difficult to understand the implications of the vote.”

ISS will accept comments on the proposal through November 11, 2010.  ISS plans to release its final 2011 U.S. and international policy updates late-November and its Global Policy Summary and Concise Guidelines in late-December.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.