Final Say-on-Pay Rules Include Delay for Small Companies

The Securities and Exchange Commission issued final rules to implement mandatory say-on-pay votes for public companies. The 152-page adopting release varies somewhat from the proposed rules, including a two-year delay for smaller reporting companies.

In a three-to-two vote at a Jan. 25 open meeting, the SEC adopted rules to implement Section 951 of the Dodd-Frank Act, which requires advisory shareholder votes to approve executive pay, votes on the frequency of say-on-pay votes, and enhanced disclosure of and votes to approve golden parachute agreements in connection with mergers and acquisitions. Under the law, say-on-pay votes are required at least every three years, beginning with the first annual shareholders' meeting taking place on or after Jan. 21, 2011. Companies must also hold shareholders votes on the frequency of say-on-pay with the option of one, two, or three years, or to abstain. Frequency votes are required to be held every six years.

“Companies should look at the disclosure requirements under the final rule and check whether they need to change anything in their draft proxies,” says Ronald Mueller, a partner in the law firm Gibson Dunn & Crutcher. For example, the final rule requires that companies disclose that they are providing the say-on-pay and frequency vote as required pursuant to Section 14A of the Securities Exchange Act. In addition, Item 21 of the proxy rules requires companies to state the voting standard applicable to proposals and the effect of abstentions.

The adopting release clarifies that say-on-pay and frequency vote rules only apply for annual or special meetings at which directors will be elected. Smaller reporting companies–generally those with less than $75 million in public float—don't have to hold them until their annual meetings on or after Jan. 21, 2013. Roughly 7,300 companies are subject to the rules. Fewer than 1,500 of those would come under the deferral, SEC spokesman John Nester said. The phase-in for smaller reporting companies doesn't apply to shareholder advisory votes on golden parachutes.

The two-year delay gives smaller companies time to prepare for implementation and to observe how the rule operates for their larger counterparts, SEC Chairman Mary Schapiro said. It also gives the SEC time to decide whether to make adjustments to the rule before it applies to the smaller companies.

Kathleen Casey and Troy Paredes, the two dissenting commissioners, said the final rules don't provide enough relief for smaller companies or newly public companies. They wanted a permanent exemption for smaller companies and a phase-in until after their first annual meeting for newly public companies. As adopted, the rule will require newly public companies to report amounts paid while they were private in their first proxies and annual reports following an initial public offering.

Beyond companies that can take advantage of the delay, the changes in the final rule are unlikely to cause companies to change course on their say-on-pay disclosure or recommendations on frequency, says James Barrall, a partner in the law firm Latham & Watkins. Any companies that don't plan to include a recommendation on the frequency vote, however, may want to reconsider, since those that don't make a recommendation lose discretionary authority to vote shares for any shareholders who return proxies but don't choose a frequency.

Other Changes, Clarifications

“Companies should look at the disclosure requirements under the final rule and check whether they need to change anything in their draft proxies.”

—Ronald Mueller,

Partner,

Gibson Dunn & Crutcher

The Commission also changed the standard for excluding say-on-pay- and frequency-related shareholder proposals. Under the final rule, companies can only exclude such proposals if one of the frequency choices gets a majority of the votes cast and the company adopts a frequency policy in line with that choice. That's a change from the proposing release, which would've allowed companies to exclude such proposals if the company adopted a frequency policy consistent with the plurality of votes cast on the most recent frequency vote. That could render the frequency vote meaningless, since in some cases one frequency option might not get a majority vote, Casey argued.

“Where there is no clear mandate, management is not likely to be influenced by the shareholder vote because there is no way to guard against a shareholder proposal that second-guesses their frequency determination,” she said. That may drive companies to simply adopt the recommendation of proxy advisory firms. “We may have inappropriately placed our thumb on the scale to ensure that companies and shareholders have no real choice on the frequency vote but to do what the proxy advisory services recommend,” Casey said. Currently, Institutional Shareholder Services, the largest proxy advisory firm in the United States, is recommending that companies hold say-on-pay votes annually.

OPPOSING VIEWS

The following statements from SEC Chair Mary Schapiro and Commissioners Kathleen Casey and Troy Paredes show different viewpoints when it comes to smaller companies and the final say-on-pay rule:

The delayed compliance date for smaller reporting companies is designed to allow those companies to observe how the rules operate for other companies, and should allow them to better prepare for implementation of the rules.

Delayed implementation for these companies will also allow the Commission to evaluate the implementation of the adopted rules by larger companies and provide us with the additional opportunity to consider whether adjustments to the rule would be appropriate for smaller reporting companies before the rule becomes applicable to them.

I believe that this two-year deferral is a balanced and responsible way for the Commission to ensure that its rules do not disproportionately burden small issuers. Section 951 of the Dodd-Frank Act authorizes the Commission to exempt an issuer or class of issuers, but only after considering a number of factors—including whether this disproportionate burden exists. The two-year deferral period is designed to assist the Commission in its consideration of these factors.

—Mary Schapiro,

Chairman,

Securities and Exchange Commission

I support the proposed rule to implement amendments to the net worth standard for accredited investors under Section 413(a) of Dodd-Frank. However, I am, unfortunately, unable to support the staff's recommendation on adopting rules implementing Section 951 of Dodd-Frank, which requires advisory shareholder votes on executive compensation and golden parachute compensation — provisions widely referred to as “say-on-pay.”

My analysis of both of these releases focuses primarily on the way we have considered and approached the adverse impact and burdens on smaller companies and capital formation in our implementation of the new law's requirements. The staff's recommendation relating to the net worth calculation for accredited investors gives due consideration to the implications of this standard on small companies and capital formation. Conversely, I believe the say-on-pay rules we are adopting today are unduly restrictive and impose unnecessary burdens, particularly on smaller reporting companies, with minimal corresponding benefits for investors.

—Kathleen Casey,

Commissioner

Securities and Exchange Commission

First, I disagree with the final rule's treatment of smaller reporting companies. The Commission has afforded smaller reporting companies a temporary exemption from the say-on-pay and frequency votes until 2013; the Commission has provided no similar phase-in for smaller companies when it comes to golden parachute compensation.

Simply put, the Commission did not do enough for smaller companies. The Commission should have afforded smaller public companies an outright exemption from the new regulatory requirements.

Second, the final rule should have included an exemption for newly public companies. In particular, a company should be exempt from the say-on-pay and frequency votes for a limited period after going public. One option — which the final rule does not embrace — would have been to exempt newly public companies from the voting requirements until after the company's first annual meeting.

The exemptions for smaller and newly public companies that I favor are grounded in my view that the Commission needs to do more to avoid unduly burdening smaller public companies with unwarranted regulatory demands.

—Troy Paredes,

Commissioner,

Securities and Exchange Commissioner

Source

Source: Securities and Exchange Commission.

The change to majority of votes cast “gives shareholders a stick,” says Sanjay Shirodkar, of counsel at DLA Piper and former SEC special counsel. “The SEC put some teeth into the advisory votes, so companies aren't free to ignore them.”

Monsanto, the first company to hold a frequency vote where shareholders voted in favor of a different option than recommended by management, disclosed in an 8-K filed the day of its Jan. 25 meeting that it would adopt the option chosen by its shareholders. The company had recommended a triennial vote, but its investors overwhelmingly favored an annual vote.

The final rules require certain disclosure in the annual meeting proxy regarding the say-on-pay and frequency votes, including whether they're non-binding. They also require additional disclosure in the Compensation Discussion and Analysis regarding whether and how companies considered the results of their most recent say-on-pay vote. Smaller reporting companies aren't required to provide CD&A disclosure, and therefore don't have to provide that information.

Following a shareholder frequency vote, companies must disclose their decision on say-on-pay vote frequency in an 8-K no later than 150 calendar days after the vote, but within 60 days prior to the deadline for submitting shareholder proposals for the subsequent annual meeting. The proposed rule would've required disclosure in 10-Qs for the period during which the frequency vote occurred, or in the 10-K if it was during the fourth quarter.

The final rule also requires new detailed disclosure under Item 402(t) of Regulation S-K about golden parachute arrangements with named executive officers of both acquiring and target companies in connection with certain “significant corporate transactions.” The SEC expanded that disclosure beyond mergers and acquisitions to include going-private transactions and third-party tender offers. Shareholder advisory votes on golden parachutes are required for meetings where shareholders vote to approve such transactions, unless the parachutes were subject to a previous say-on-pay vote.

Even if they don't have a transaction in the works, companies should weigh whether they want to voluntarily provide the detailed parachute disclosure in their annual meeting proxies to take advantage of an exception from the say-on-parachute vote if a transaction occurs later. “That decision has to be made on an issuer by issuer basis,” says Andrew Liazos, a partner at McDermott Will & Emery. “Companies need to consider how much more disclosure they would have to provide to satisfy Item 402(t) and whether it could tilt their SOP vote in a negative way.”

The say-on-golden-parachutes rules apply for all public companies (including smaller reporting companies) to any merger proxy statement or other covered transactional document filed on or after April 25. The rest of the rules take effect 60 days after publication in the Federal Register.