Recent Developments and Important Considerations
for Companies Preparing for the 2010 Proxy Season
September 14, 2009
There have been several important developments that public companies should consider as they begin preparations for the 2010 proxy season, and recent proposals and announcements by regulatory agencies, federal and state governments (including Delaware), and other prominent organizations offer the promise of more change to come. For example, the New York Stock Exchange (NYSE) has amended the rules governing broker discretionary voting, the SEC has proposed new rules addressing such issues as proxy access, executive compensation, and corporate governance disclosures, and there are a multitude of legislative proposals addressing similar topics that have recently been introduced in Congress. In addition, Delaware has made some significant new changes to its corporate law relevant to shareholder meetings, while a committee of the American Bar Association (ABA) has released an important paper on governance issues and the NYSE has announced a new Commission on Corporate Governance.1
In the next few months, publicly listed companies whose fiscal year coincides with the calendar year will need to start planning for their next annual meeting. This planning should include a review of these recent developments, as these developments are likely to require some changes to how companies have traditionally planned for annual meetings. This WSGR Alert is designed to briefly outline some of the more significant changes, as well as potential changes, to the annual meeting process and provide some recommendations with respect to those changes that public companies should consider in advance of their annual meetings.
Amendment to NYSE Rule 452
On July 1, 2009, following (at least in part) the recommendations of the NYSE Proxy Working Group2 and the NYSE, the Securities and Exchange Commission (SEC) approved a long-anticipated amendment to NYSE Rule 4523 to prohibit brokers from voting in uncontested director elections on behalf of the beneficial owners who are their clients without receiving specific voting instructions from those clients.4
The direct effect of the amendment to NYSE Rule 452 is that, beginning with shareholder meetings held on or after January 1, 2010,5 brokers cannot vote shares on behalf of their clients in any director elections without specific voting instructions from their clients. This potentially decreases the number of votes cast in director elections, especially by "retail" investors, or individual investors who hold their shares in street name.
The percentage of retail investors voting in uncontested elections has been declining in recent years, particularly with the advent of electronic proxy access (which ironically was adopted, at least in part, to make it easier for retail investors to vote). Public companies are likely to find that institutional investors have a greater influence at annual meetings, as the percentage of retail investors voting in such elections continues to decline and brokers are not allowed to vote the uninstructed shares.6 Companies that require directors to be elected by majority voting (as opposed to plurality voting) are more likely to feel the impact of the greater influence of institutional investors.7
Public companies may want to consider taking the following actions in response to amended NYSE Rule 452 prior to their 2010 annual meeting:
- Be proactive and understand the composition of the company's shareholder base prior to the meeting, as this will assist the company in understanding how significant the effect of the amendment to NYSE Rule 452 will be on the election of directors in the future and can help guide decisions about engaging with shareholders, both during the year as well as during proxy solicitations.
- Consider hiring a proxy solicitor in connection with the annual shareholder meeting or a general engagement with a proxy solicitor so that the company can receive periodic reports on its shareholder base. While this is, of course, an additional cost, it may be necessary depending on the company's shareholder base, the potential need for obtaining shareholder lists, follow-up mailings, and telephone solicitation of shareholders.
- Review the majority voting provisions that the company has adopted, if any, with respect to the treatment of abstentions and broker non-votes in the outcome of director elections, to determine the impact of the amended NYSE Rule 452.
A. SEC Proxy Access Proposed Rules
On May 20, 2009, the SEC, by a narrow 3-2 margin, voted to propose new Rule 14a-11 under the Securities Exchange Act of 1934, as amended (the Exchange Act), and an amendment to Exchange Act Rule 14a-8. These Exchange Act rules govern shareholder access to the proxy materials of public companies.
Proposed Exchange Act Rule 14a-11 would, where not prohibited by applicable state law or a company's charter documents, grant proxy access for director elections to a shareholder, or a group of shareholders, who has owned for at least one year shares representing:
- at least 1 percent of the voting securities of a "large accelerated filer" (a company with an aggregate worldwide market value of the voting and non-voting common equity held by its non-affiliates of $700 million or more) or of a registered investment company with net assets of $700 million or more;
- at least 3 percent of the voting securities of an "accelerated filer" (a company with an aggregate worldwide market value of the voting and non-voting common equity held by its non-affiliates of $75 million or more but less than $700 million) or of a registered investment company with net assets of $75 million or more but less than $700 million; or
- at least 5 percent of the voting securities of a "non-accelerated filer" (a company with an aggregate worldwide market value of the voting and non-voting common equity held by its non-affiliates of less than $75 million) or of a registered investment company with net assets of less than $75 million.
Each eligible shareholder, or eligible group of shareholders, would be permitted to include in a company's proxy materials the greater of one nominee or nominees representing up to 25 percent of a company's board of directors.
Nominating Shareholder Requirements
Proposed Exchange Act Rule 14a-11 would require that the new Schedule 14N be filed with the SEC by nominating shareholders by the date specified by the company's advance notice provision, or where no such provision is in place, no later than 120 calendar days prior to the date that the company mailed its proxy materials for the prior year's annual meeting. Schedule 14N would require that nominating shareholders, among other things: (1) disclose the number, percentage, and length of ownership of all company securities owned; (2) sign a statement declaring their intent to continue to own such shares at least until the date of the annual meeting at which their nominee(s) would stand for election; and (3) certify that they are not holding their shares for the purposes of effecting a change of control of the company or gaining more than minority representation on such company's board of directors.
Shareholder Nominee Requirements
Shareholder nominees included in a company's proxy materials under proposed Exchange Act Rule 14a-11 would be required to satisfy the independence standards of the national securities exchanges or national securities associations applicable to the company. Further, the candidacy and/or board membership of a shareholder nominee must not violate applicable laws and regulations.
The SEC also voted to propose an amendment to Exchange Act Rule 14a-8(i)(8) that would expand the right of shareholders, where not in conflict with state law, to include proposals in a company's proxy materials. Exchange Act Rule 14a-8(i)(8) currently permits companies to exclude a shareholder proposal if the proposal "relates to an election." The proposed amendment to Exchange Act Rule 14a-8(i)(8) would remove the ability of a company to exclude shareholder proposals by eligible shareholders that seek to amend, or request an amendment to, provisions of a company's charter documents regarding a company's director-nomination procedures and disclosure provisions (so long as such shareholder proposals would not conflict with proposed Exchange Act Rule 14a-11).
The proposed SEC proxy access rules are expected to be sharply debated. The SEC has already received over 500 comment letters and there have been several rumors of possible lawsuits against the SEC should it proceed with the adoption of the proposed proxy access rules. This rule proposal marks the third time in less than six years that the SEC has proposed rules related to proxy access. The SEC has, however, considered proxy access rules a number of times since 1942, but has rejected the concept each previous time.8 Given the intense debate expected on the SEC proposal and the competing legislative proposals described below, it is unclear at this time what form the rules, if adopted, would take. That said, there is considerable speculation that the SEC may adopt some form of proxy access in the near future, and this type of rule may have a significant impact on a company's annual meeting.
B. Proxy Access Amendments to Delaware Law
On April 10, 2009, Delaware House Bill #19,9 which amends the Delaware General Corporation Law (DGCL), was signed into law, and became effective August 1, 2009. The amendments include adding a new Section 112 to the DGCL, which provides that a Delaware corporation may, but is not required to, adopt a bylaw that allows individuals nominated by stockholders to be included in the company's proxy solicitation materials, including any form of proxy distributed by the company. The "proxy access" bylaw may impose "lawful" procedures or conditions on proxy access, such as:
- minimum record or beneficial ownership or duration of ownership;
- receipt of information from the nominating stockholder concerning the stockholder and the stockholder's nominees;
- limits on the number or proportion of directors that may be nominated by stockholders as well as limits based on whether the stockholder previously sought to nominate individuals;
- prohibitions on nominations by any stockholder if such person, any nominee of such person, or any affiliate or associate of such person or nominee has acquired or publicly proposed to acquire shares constituting a specified percentage of the voting power of the company's outstanding voting stock within a specified period before the election of directors; and
- agreements from nominating stockholders to indemnify the company in respect of any loss arising as a result of any false or misleading information or statement submitted by the nominating stockholder in connection with a nomination.
Section 112 permits a director election contest using a company's own proxy statement and card, where stockholders' director nominees are considered for election without requiring the nominating stockholders to bear the cost and expense of printing their own proxy statement and soliciting proxies. Proxy access bylaws would, if adopted by companies, give stockholders unprecedented access to a corporation's proxy materials in director elections, and could make it much easier for stockholders to engage in proxy contests. Section 112 appears to give some discretion to boards of directors to appropriately monitor stockholders' access to a company's proxy. However, it remains to be seen how these provisions will be interpreted by the courts.
Although it is unclear how Section 112 will be impacted by the SEC's proposed proxy access rules, there is potential for a conflict between the two regulatory regimes since the SEC's proposed proxy access rules could limit the restrictions a company is permitted to impose on proxy access through a proxy access bylaw under Delaware law.
Current Legislative Proposals
Multiple bills have been introduced in the Senate and House of Representatives addressing executive compensation, say-on-pay advisory votes, corporate governance standards, disclosure requirements, and other related issues. The Shareholder Bill of Rights Act, the Excessive Pay Shareholder Approval Act, the Excessive Pay Capped Deduction Act, the Shareholder Empowerment Act, and the Corporate and Financial Institution Compensation Fairness Act (each of which is described below) are expected to be sharply debated. Given the intense lobbying expected, multiple competing legislative initiatives, and recently proposed SEC rules, it is unclear what form any legislation, if signed into law, would take.
A. Shareholder Bill of Rights Act of 2009
On May 19, 2009, Senator Charles Schumer introduced the Shareholder Bill of Rights Act of 2009 in the Senate, which is currently being reviewed by the Senate Committee on Banking, Housing, and Urban Affairs. The Shareholder Bill of Rights Act, if adopted, would have a widespread effect on all publicly traded companies in the United States.
Advisory Say-on-Pay Votes
The Shareholder Bill of Rights Act would require the SEC to adopt, within one year of enactment, rules mandating that all public companies provide their shareholders with:
- an annual advisory vote on executive compensation, commonly referred to as "say-on-pay," and
- an advisory vote on "golden parachute" arrangements, or any compensation arrangement with principal executive officers based on or otherwise related to a merger, acquisition, or sale of all or substantially all of the assets of the company, taken at the time of shareholder approval of such a transaction.
The Shareholder Bill of Rights Act is not the only say-on-pay legislation that has been introduced in Congress. Senator Richard Durbin had previously introduced the Excessive Pay Shareholder Approval Act, which would require a supermajority shareholder vote to approve excessive compensation of any employee of a publicly traded company. Additionally, the House of Representatives has passed the Corporate and Financial Institution Compensation Fairness Act of 2009, currently before the Senate, which also contains say-on-pay requirements.
The Shareholder Bill of Rights Act would also clarify that the SEC has the authority to determine the use of a public company's proxy with respect to the nomination and election of directors by shareholders, and would direct the SEC to establish rules requiring public companies to grant proxy access for director elections to a shareholder, or a group of shareholders acting by agreement, who has beneficially owned, directly or indirectly, at least 1 percent of the voting securities of a company for at least two years preceding an annual meeting. This would allow an eligible shareholder to launch a director election contest using the company's proxy card, where the shareholder's director nominees are considered for election without the shareholder having to bear the cost and expense of issuing its own proxy statement and solicitation.
Separately, on May 20, 2009, the SEC voted to propose proxy access rules, as discussed in detail above. The Shareholder Bill of Rights Act and the SEC's proposed rules both follow a recent amendment to the Delaware General Corporation Law permitting proxy access bylaws, as described above.
Corporate Governance Standards
The Shareholder Bill of Rights Act would require the SEC to direct the national securities exchanges and national securities associations to establish rules within one year that require public companies to take a number of corporate governance-related actions, including the following:
- Independent Board Chairman. The Shareholder Bill of Rights Act would require that the chair of the board of directors be independent, as determined in accordance with the rules of the exchange on which the securities of such company are listed, and not have previously served as an executive officer of the company.
- De-classified Boards of Directors. The Shareholder Bill of Rights Act would prohibit classified boards and require that each director stand for election annually.
- Majority-Vote Standard for Uncontested Director Elections. The Shareholder Bill of Rights Act would require majority voting in uncontested elections but would permit plurality voting in contested elections. If a director does not receive the necessary number of votes to be elected, such director would be required to tender his or her resignation and the board of directors would be required to accept such resignation and determine when the resignation becomes effective, avoiding a "holdover" situation under state law.
- Board Risk Management Committee. The Shareholder Bill of Rights Act also would require the boards of directors to establish a special committee to be comprised entirely of independent directors responsible for the establishment and evaluation of the company's risk management practices.
The Shareholder Bill of Rights Act would also permit the SEC to exempt certain companies from such requirements, based on market capitalization, public float, or other criteria as determined by the SEC.
B. Excessive Pay Shareholder Approval Act and the Excessive Pay Capped Deduction Act of 2009
On May 7, 2009, Senator Richard Durbin introduced in the Senate the Excessive Pay Shareholder Approval Act, which is currently being reviewed by the Senate Committee on Banking, Housing, and Urban Affairs, and the Excessive Pay Capped Deduction Act of 2009, which is currently being reviewed by the Senate Committee on Finance.
Excessive Pay Shareholder Approval Act
The Excessive Pay Shareholder Approval Act would require a supermajority vote (60 percent) of shareholders to approve a compensation structure in which any employee is paid more than 100 times the average compensation paid to all employees of that company. The Excessive Pay Shareholder Approval Act also requires proxy disclosure about the amount of compensation paid to the lowest and highest-paid employees, the average compensation paid to all employees, the number of employees paid more than 100 times the average employee compensation, and the total compensation paid to employees who are paid more than 100 times the average employee compensation.
Excessive Pay Capped Deduction Act
The Excessive Pay Capped Deduction Act would amend the Internal Revenue Code to limit the federal income tax deduction for compensation paid to executives to 100 times the average employee compensation of that company and requires companies that pay such "excessive compensation" each year to file a report with the Department of the Treasury disclosing compensation paid to the lowest and highest-paid employees, average compensation paid to all employees, number of employees paid more than 100 times the average employee compensation, and amounts paid to employees who are paid more than 100 times the average employee compensation.
C. The Shareholder Empowerment Act of 2009
On June 12, 2009, Representative Gary Peters introduced in the House of Representatives the Shareholder Empowerment Act of 2009 (the Empowerment Act), which is currently being reviewed by the House Financial Services Committee. The Empowerment Act would implement the corporate governance recommendations made by the Council of Institutional Investors, a shareholder advocacy group, in December 2008. Several provisions of the Empowerment Act mirror the Shareholder Bill of Rights Act. For instance, both bills call for the SEC to adopt rules requiring public companies to hold annual advisory votes on executive pay (say-on-pay votes), to allow shareholders to nominate board candidates to appear in management proxy statements (proxy access), to adopt a majority-vote standard in uncontested director elections, and to appoint an independent chair of the board of directors. The Empowerment Act, however, goes further than the Shareholder Bill of Rights Act on certain executive compensation issues.
The Empowerment Act would require the SEC to adopt rules providing shareholders of a public company an annual say-on-pay advisory vote for the senior executive officers included in the SEC-mandated summary compensation table and other compensation-related disclosures. The Empowerment Act also implements additional restrictions on other aspects of executive compensation, and would require the SEC to adopt rules for public companies (or to require the stock exchanges to adopt rules) regarding the following matters:
- Independent Compensation Advisors. The Empowerment Act would require that a public company that retains an advisor in conjunction with negotiating employment contracts or compensation agreements with the company's executive officers ensure that such advisor is independent of the company, its executive officers, and its directors, and that such advisor reports solely to the company's board of directors or a board committee. Moreover, a public company would not be permitted to agree to indemnify or limit the liability of its compensation advisors.
- Claw-Back of Unearned Performance-Based Pay. The Empowerment Act would require a public company to develop and disclose a policy for reviewing, and recovering or canceling if feasible, any performance-based compensation made to its executive officers based on fraud, financial results that require restatement, or other causes specified by the SEC.
- Severance Agreements Tied to Performance. The Empowerment Act would prohibit a public company's board of directors or board committee from entering into an agreement providing for severance payments to any senior executive officer who is terminated due to poor performance. The Empowerment Act would also require that poor performance, as determined by the board of directors, be included in the definition of "cause" in agreements that allow for a senior executive to be terminated for cause.
- Improved Disclosure of Performance Targets. The Empowerment Act would require public companies to provide additional disclosure regarding the specific performance targets used to determine the eligibility of senior executive officers for bonus, equity, and incentive compensation, including situations in which current SEC rules may permit non-disclosure of such targets due to potential competitive harm.
With regard to corporate governance matters, the Empowerment Act would require the SEC to adopt rules requiring public companies to:
- implement majority voting for uncontested director elections;
- allow shareholder access to the proxy in director elections (which the SEC subsequently proposed); and
- limit the position of independent chair of the board of directors to a person who has not previously served as an executive officer or certain other specified positions at the company.
In addition, the Empowerment Act would require the SEC to adopt rules prohibiting broker voting in the absence of shareholder instructions in uncontested director elections (which the SEC subsequently approved).
D. Corporate and Financial Institution Compensation Fairness Act of 2009
On July 31, 2009, the U.S. House of Representatives passed the Corporate and Financial Institution Compensation Fairness Act of 2009 (the Compensation Fairness Act), which was sent to the Senate for consideration and referred to the Senate Committee on Banking, Housing, and Urban Affairs on August 3, 2009. The Compensation Fairness Act addresses, among other things, say-on-pay and compensation committee/consultant independence.
The Compensation Fairness Act requires a separate annual non-binding shareholder vote on all executive compensation disclosed in the annual proxy statement (i.e., all arrangements disclosed in the compensation disclosure and analysis (CD&A), the compensation committee report, the compensation tables, and all related materials), as well as a separate non-binding shareholder vote on golden parachute arrangements for any shareholder meeting involving a merger, acquisition, or sale of the assets of the company.
Compensation Committee Independence
The Compensation Fairness Act also requires that compensation consultants, legal counsel, and other advisors to the compensation committees satisfy independence standards to be established by the SEC. Additionally, the Compensation Fairness Act requires that members of a compensation committee satisfy new standards for independence similar to the standards currently in place for members of an audit committee under SEC rules. Under the Compensation Fairness Act, compensation committees would have the authority and funding to retain independent compensation consultants, legal counsel, and other advisors and companies also will be required to disclose in their annual proxies whether independent compensation consultants were retained by the compensation committee.
Enhanced Compensation Structure Reporting for Covered Financial Institutions
The Compensation Fairness Act proposes to regulate the compensation structures of financial institutions with assets of $1 billion or more (so-called "covered financial institutions"), which is not limited to recipients of TARP financial assistance, as follows:
- Each covered financial institution must report to an appropriate federal regulatory agency details of all its incentive compensation arrangements, in sufficient detail for the regulatory agency to determine whether the compensation structure (1) is aligned with sound risk management, (2) is structured to account for the time horizon of risks, and (3) meets other criteria appropriate to reduce unreasonable incentives for employees to take undue risks that could threaten such covered financial institution or have serious effects on economic conditions or financial stability.
- The appropriate federal regulatory agencies must also issue regulations prohibiting any incentive compensation arrangements or features that are determined to encourage inappropriate risks that could threaten the safety and soundness of such covered financial institution or have serious adverse effects on economic conditions or financial stability.
Additional Proxy Disclosure Rules Proposal by the SEC
On July 1, 2009, the SEC voted to propose rules that would require additional disclosure in annual reports and proxy statements regarding the relationship of a company's overall compensation policies to risk, director and nominee qualifications, company leadership structure, and the potential conflicts of interest of compensation consultants, among other things. The SEC is expected to act on the rules prior to the 2010 proxy season.
Enhanced Compensation Discussion and Analysis Disclosure
The proposed SEC rules would broaden the scope of the CD&A disclosure to require discussion and analysis of a company's compensation policies and overall actual compensation practices for employees generally, not just for executive officers, if the risks arising from those compensation policies or practices may have a material effect on the company. The proposed change is in part a response to concerns raised by regulators and investors that compensation structures helped to fuel the current financial crisis by encouraging excessive risk-taking to achieve short-term goals with insufficient regard for the long-term well-being of companies. The SEC believes that expanded discussion about how public companies reward and incentivize employees, to the extent that such policies and practices create risk, will provide investors with a better understanding as to how compensation policies may lead to increased, excessive, or inappropriate risk-taking by employees and how companies are managing those risks.
Although the situations that will require disclosure will be specific to each company based on the company's compensation programs, in the proposed rules the SEC provided several examples of situations that could potentially trigger expanded discussion and analysis. There may, however, be additional situations that are not explicitly set out in the SEC's examples where a company's compensation programs could raise material risks to the company that warrant expanded disclosure pursuant to the proposed rules.
Revised Stock and Option Award Disclosure in Compensation Tables
The proposed rules would revise the disclosure required in several executive compensation tables currently found in proxy statements concerning stock and option awards to require disclosure of the aggregate grant-date fair value of awards computed in accordance with Financial Accounting Standards (FAS) No. 123R, rather than the dollar amount recognized for financial statement reporting purposes, as currently required. The proposed change is intended to enable investors to better evaluate the amount of equity compensation awarded in the applicable fiscal year, which the SEC believes will be more accurately reflected using the full grant-date fair value of the awards.
If adopted, the SEC anticipates that the proposed rules would be effective for the 2010 proxy season. The SEC is considering whether to require companies to conform disclosures in the summary compensation table with respect to prior fiscal years to the new rules. However, the SEC does not intend to require companies to reflect any changes in the individuals identified as named executive officers for prior fiscal years that would occur as a result of recalculating total compensation for those years.
Although the rules are currently in proposed form, public companies may want to consider:
- updating the compensation committee on the proposed rules, and
- in anticipation of the SEC potentially finalizing the rules in their current form, tracking both the grant-date fair value and dollar value of stock and option awards granted during fiscal 2009 and compiling information with respect to the grant-date fair value of stock and option awards granted in prior fiscal years that will need to be included in the 2009 summary compensation table.
Compensation Consultant Disclosure
The proposed rules would require enhanced disclosure in proxy statements regarding compensation consultants and potential conflicts of interest. Specifically, in the event a compensation consultant (or its affiliates) provides consulting services related to a company's executive or director compensation and also provides additional services to the company, the company would be required to provide the following additional disclosures with respect to such compensation consultant:
- a description of the nature and extent of the additional services provided to the company by the compensation consultant and any of its affiliates;
- the aggregate fees paid for all additional services and for work related to executive and director compensation consulting;
- whether the decision to engage the compensation consultant for any other services was recommended or made by management; and
- whether the board of directors or the compensation committee approved the other services.
The enhanced disclosure is intended to provide investors with more complete information concerning the role of compensation consultants to enable investors to better assess the financial interests and objectivity of a compensation consultant when non-executive compensation services are provided.
Although the rules are currently in proposed form, public companies may want to consider:
- updating the board of directors or compensation committee on the proposed rules, and
- taking steps now to assess the scope of the company's engagement, if any, of compensation consultants, including fee arrangements, for purposes of: (1) determining whether the structure of current arrangements may compromise (or appear to compromise) the objectivity of the compensation consultants' recommendations with respect to executive or director compensation as a result of the fees earned in connection with the additional services provided to the company; and (2) assessing the enhanced disclosure that would be required under the current version of the proposed rules.
Expanded Director and Nominee Disclosure
The proposed rules would require additional disclosure regarding the qualifications of each director and nominee listed in an annual report, proxy statement, or registration statement, including:
- the particular experience, qualifications, attributes, or skills that qualify each such person to serve as a director of the company, and as a member of any committee that the person serves on or is chosen to serve on, in light of the company's business;
- any directorships at public companies held by each such person at any time during the past five years, instead of only currently held directorships; and
- certain legal proceedings involving each such person during the last 10 years, instead of only in the last five years.
Although the rules are currently in proposed form, public companies may want to consider:
- updating the board of directors or nominating committee on the proposed rules, and
- reviewing the SEC's proposed expanded disclosure rules when evaluating persons for nomination or re-nomination to the company's board of directors and board committees.
Disclosure of Leadership Structure
The proposed rules would require disclosure in a proxy statement of a company's leadership structure and a discussion of why the company believes its leadership structure is the best structure for the company, including:
- whether and why the company has chosen to combine or separate the chief executive officer and board chair positions; and
- whether and why the company has a lead independent director and the role of the lead independent director in the leadership of the company.
Although the rules are currently in proposed form, public companies may want to consider:
- updating the board of directors or nominating committee on the proposed rules, and
- reviewing the SEC's proposed expanded disclosure rules when re-examining the company's corporate governance generally, and when considering changes to the company's leadership structure specifically.
Disclosure of the Board's Role in the Risk Management Process
The proposed rules would require disclosure in a proxy statement about the board's role in the company's risk management process, and the effect, if any, that this has on the way the company has organized its leadership structure. The SEC believes that disclosure should provide information about how a company perceives the role of its board and the relationship between the board and senior management in managing the material risks facing the company.
Although the rules are currently in proposed form, public companies may want to consider:
- updating the board of directors or audit committee, which often has been delegated authority to oversee management's implementation of risk management, on the proposed rules, and
- if it has not been done recently, comprehensively re-evaluating and discussing with the board of directors or audit committee the company's risk management function.
Real-Time Disclosure of Shareholder Voting Results
The proposed rules would also require disclosure of voting results from a shareholder meeting to be made within four business days after the end of the meeting in a current report on Form 8-K, rather than being made in a Form 10-Q or Form 10-K filed with respect to the period during which the meeting was held. If the meeting involved a contested director election and definitive voting results are not available within four business days of the meeting, companies would be required to disclose preliminary voting results on a Form 8-K within four business days of the meeting and to file an amended Form 8-K within four business days of receiving certified voting results.
Other Proposed Rules – Say-on-Pay for TARP Recipients
In addition, as required by the Emergency Economic Stabilization Act of 2008, on July 1, 2009, the SEC proposed requiring public companies receiving money from the Troubled Asset Relief Program (TARP) to provide an advisory shareholder vote in their proxy solicitations on executive compensation that is disclosed in the proxy statement during the period in which any obligation arising from financial assistance provided under TARP remains outstanding.
Proposed Amendments to NYSE Corporate Governance Standards
On August 26, 2009, as amended on September 10, 2009, the NYSE issued proposed modifications to some of its corporate governance listing requirements set forth in Section 303A of the NYSE Listed Company Manual. The proposed changes are generally technical in nature and are primarily intended to clarify certain existing disclosure requirements of NYSE Rule 303A, to codify certain interpretations made since the rules were enacted, and to replace certain disclosure requirements by incorporating into the NYSE's rules the applicable disclosure requirements of the SEC contained in Regulation S-K. While the NYSE intends for these amendments to become effective on January 1, 2010, the SEC has not yet issued this proposal for comment. For a detailed description of the proposed rule changes, please see "NYSE Rule Filings" at http://www.nyse.com/regulation/nyse/1220033210220.html.
Preparing for the 2010 Proxy Season and Beyond
The changes to NYSE and Delaware rules that have already been approved may require significant effort by companies preparing for their 2010 annual meeting, and obviously considerably more efforts may be needed depending upon whether any additional legislation is enacted or regulatory action currently under consideration is adopted. Although there may be only limited visibility to future developments in this area, there are some specific steps we are recommending that companies consider in advance of the 2010 proxy season. These steps include the following:
- Know the company's shareholders. This repeats a recommendation that we have made in the past, but it continues to grow in importance. Public companies should identify their shareholder base, and not just their largest or most active shareholders. Public companies may want to reach out now to some of these shareholders, as it is often not ideal to speak to a large shareholder for the first time during proxy season. Companies should also re-evaluate whether, or to what extent, to use the notice and access rules for proxy delivery, based on whether the number of shareholders who vote decreases if a hard copy of the company's proxy materials is not mailed to them other than by special request.
- Review the company's corporate governance profile. Several elements of the legislative proposals described in this WSGR Alert are seeking to create "best practices" for corporate governance in publicly traded companies by, for example, making changes (1) to make majority voting mandatory in uncontested director elections; (2) to require an independent chair of the board to separate the positions of CEO and chair of the board; and (3) to require companies to declassify their boards. Although this "one size fits all" approach to governance may present significant problems for many companies, it can often be difficult to get institutional investors and/or proxy advisory firms to evaluate these issues on an individual company basis. As a result, public companies should assess to what extent their corporate governance profile meets these best practices and the reasons why their current governance profile makes sense (or whether it no longer does), and consider what changes would need to be made in these areas if the legislation is enacted as proposed. More broadly, management and the board, working with their advisors, should consider whether the company's corporate governance profile is appropriate in light of the specific issues facing the company, from a business and shareholder perspective. In our experience we have often found that best practices in corporate governance matters may not always be appropriate for a particular company, and it is important that a board and management recognize early on when they have a situation that may result in challenging questions by shareholders and others so that the company can be prepared with an appropriate response.
- Consider taking a more comprehensive, year-round view of director elections and other proposals to be voted on. For example, companies should understand what board actions would cause a proxy advisory group to recommend voting against a director nominee or other proposal at an annual meeting. Since many proxy advisory groups recommend voting against director nominees and other proposals as a result of perceived corporate governance concerns, as discussed above, companies should consider periodically conducting a review of corporate governance policies and procedures.
- Re-examine the independence of compensation committee members. Under the legislative proposals described above, compensation committee members would need to meet independence requirements similar to those that apply to audit committee members. This means that compensation committee members would not be able to, directly or indirectly (other than in their capacity as a board member or committee member), accept any consulting, advisory, or other compensatory fee from the company. If current members of a public company's compensation committee do not currently meet audit committee independence tests, the company should begin to think about whether and how to make changes to the composition of the compensation committee.
- Prepare for a say-on-pay vote. Some of the pending legislative proposals would require all publicly traded companies to hold an annual shareholders' say-on-pay vote, and this seems to be gaining influence generally, in much the same way that majority voting was a hot topic a few years ago. Although the vote would be advisory only, and would not be binding on the company, compensation committees may want to reach out now to some of the public company's largest shareholders to identify what their concerns are and what sort of response the shareholders are likely to give if presented with an advisory say-on-pay vote. More broadly, in light of the spotlight on executive compensation these days, it is particularly important for the board of directors and compensation committee to examine both the substance and process by which executive compensation is decided and determine whether the board of directors and compensation committee are comfortable with the results.
Update on Recent Corporate Governance Groups and Studies
NYSE Commission on Corporate Governance
The NYSE is forming an independent advisory commission to examine U.S. corporate governance practices and the overall proxy process. This advisory commission will take a comprehensive look at strengthening U.S. best practices for corporate governance and the proxy process. The commission will be led by Wilson Sonsini Goodrich & Rosati's chairman, Larry W. Sonsini, who also chaired the NYSE's Proxy Working Group. Members will be announced soon, and will comprise experts in all aspects of corporate governance and the U.S. proxy system so that a wide variety of perspectives can be collected, including those of public companies, shareholders, and institutional and individual investors. The commission will bring together leading experts on important issues in order to create a constructive dialog regarding corporate governance that will benefit public companies, investors, and the overall market. The commission will work with policymakers and other interested constituents to foster a comprehensive and constructive approach to corporate governance and proxy reform.
ABA Section of Business Law's Task Force on Delineation of Governance Roles and Responsibilities
In 2008, the Corporate Governance Committee of the ABA Section of Business Law established a Task Force on Delineation of Governance Roles and Responsibilities to examine whether, in the large U.S. public corporation, the decision rights and responsibilities of shareholders and boards of directors are shifting and if so, the implications of any such shift. Lawyers representing shareholder, corporate, and academic perspectives comprised the task force and engaged in a series of meetings to discuss shareholder and board roles. On August 1, 2009, the task force issued its report, which explores the delineation of governance roles and responsibilities of shareholders and directors, and the extent to which those roles and responsibilities have changed (or are changing) in light of current events. It also provides a context for policymakers, participants in the corporate governance process, and the public in considering responses to the current financial crisis. The task force's report can be accessed at http://www.abanet.org/buslaw/committees/CL260000pub/
Wilson Sonsini Goodrich & Rosati will continue to monitor these developments in the coming weeks, and we intend to issue additional alerts at the end of the year focusing on (1) the top issues facing directors in 2010 and (2) the potential for increased shareholder activism in 2010.
1 Larry Sonsini, chairman of Wilson Sonsini Goodrich & Rosati, is chairman of the NYSE Commission on Corporate Governance and David Berger, a partner at Wilson Sonsini Goodrich & Rosati, is counsel to the commission.
2 Mr. Sonsini was chairman of, and Mr. Berger was counsel to, the Proxy Working Group.
3 NYSE Rule 452 affects director elections of both NYSE- and Nasdaq-listed companies, since the NYSE rules affect how brokers licensed by the NYSE that hold stock of a Nasdaq-listed company on behalf of a client can vote in a director election of that Nasdaq-listed company.
4 NYSE Rule 452, as amended, includes a narrow exception for registered investment companies, and also codifies two existing interpretations that prohibit broker discretionary voting for material amendments to investment advisory contracts.
5 Not including meetings originally scheduled to be held before January 1, 2010, but that are postponed until after January 1, 2010.
6 In contrast, institutional investors are often required as a matter of law to vote at shareholder meetings.
7 Some companies, particularly those not incorporated in Delaware, may also have increased difficulty in obtaining a quorum. For those public companies incorporated in Delaware, if there is at least one proposal on the company's proxy card that is still "routine" under new NYSE Rule 452 (such as the ratification of auditors), broker non-votes, or an indication from a broker that they have not received instructions from a client on a routine matter, are generally counted for purposes of establishing a quorum at the annual meeting under Delaware law.
8 See SEC Staff Report: Review of the Proxy Process Regarding the Nomination and Election of Directors.
9 H.B. 19, 145th Gen. Assem. (Del. 2009) (to be codified at DEL. CODE ANN. tit. 8).