The Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act) has become law. As widely reported, the law will make the most far-reaching changes to financial regulation in the United States since the Great Depression. The Act also enacts significant new corporate governance, executive compensation and disclosure requirements that will affect all public companies, or at least all exchange listed companies, not just financial services firms. The contours of many of the new requirements will be shaped by the Securities and Exchange Commission (SEC) in a series of rulemakings. This memorandum outlines the key parts of the law applicable to public companies, possible implications of these provisions and the anticipated schedule for SEC rulemaking.
- codifies the authority of the SEC to issue proxy access rules;
- requires non-binding shareholder votes on executive compensation;
- requires SEC rulemaking on incentive compensation clawback provisions, compensation committee independence and compensation committee advisor independence;
- will require various new disclosures, including disclosures about the relationship between executive compensation and financial performance, the ratio between CEO compensation and median employee compensation, and employee and director hedging policies;
- permanently exempts non-accelerated filers from the requirement under the Sarbanes-Oxley Act for annual audits of internal control over financial reporting;
- authorizes the SEC, based upon certain findings, to treat "security-based swaps" as equity securities for purposes of the beneficial ownership rules of Sections 13 and 16 of the Securities Exchange Act; and
- authorizes the SEC to adopt changes in the timing of Schedule 13D filings by persons or groups acquiring beneficial ownership of more than 5% of a company's outstanding equity securities.
The Act also contains provisions covering broker discretionary voting and other disclosure issues. WilmerHale's summary of all of the Act's 16 titles is available here.
To prepare for the changes resulting from the Act, public companies should begin:
- considering any changes to their compensation and compensation disclosure practices that may be desirable in light of the say-on-pay vote that will be required at their 2011 annual meetings;
- evaluating the independence of their compensation committees and their advisors, which includes not only compensation consultants but also the attorneys and other advisors to the compensation committee;
- considering the implementation of policies, or revision of any existing policies, with respect to hedging of company securities by directors and employees;
- considering how to implement the required incentive compensation clawback policy (including the potential need to revise any previously adopted clawback policy or to amend existing employment agreements or arrangements);
- assessing changes to advance notice requirements and anti-takeover provisions that may be appropriate in connection with proxy access;
- developing the processes, controls and procedures that they will implement to draft and verify the new disclosures required by the Act, particularly determining the median of the annual total compensation of all employees (other than the CEO); and
- determining whether they use conflict minerals in their products and, if they do, plan for compliance with the reporting and auditing requirements of the Act.
Companies will want to closely monitor SEC rulemaking in the coming year and should consider directly participating in, or joining with industry groups to participate in, the SEC rulemaking process.
Proxy Access. The Act codifies the SEC's authority to issue a proxy access rule requiring company proxy materials to include shareholder nominees to the board of directors. The rule's details are left to the SEC's discretion. The Act allows the SEC to exempt issuers or classes of issuers from whatever rule is eventually issued, taking into account whether the rule would disproportionately burden small issuers. The SEC proposed to issue a proxy access rule in 2009, but its authority to do so was questioned by some. The Act does not specify any timetable for SEC action, but the SEC is expected to consider adoption of a final proxy access rule in the near term.
Broker Discretionary Voting. The Act will prohibit broker discretionary voting with respect to the election of directors (other than for uncontested elections to the boards of registered investment companies), executive compensation and any other significant matter as determined by the SEC. Since the exchanges have already eliminated discretionary voting in uncontested director elections, the most immediate consequence of this provision will be to prohibit discretionary voting on management say-on-pay proposals and cash compensation plans.
Majority Voting in Uncontested Director Elections Not Included in Act. Although the Senate bill would have required director nominees in uncontested elections to receive a majority of the votes cast or be required to resign, this provision was omitted from the final law.
Say-on-Pay. Effective for a company's first shareholder meeting occurring after January 21, 2011 (six months after enactment of the Act), the Act will require a periodic, non-binding shareholder vote on executive compensation. The Act provides that this shareholder vote must take place at least once every three years, with the frequency of the vote to be determined by shareholders at least once every six years. In addition, when a company seeks shareholder approval of a merger or acquisition transaction, a non-binding shareholder vote will be required with respect to the compensation executives will receive in connection with the transaction.
- These "say-on-pay" and "say-on-parachutes" votes are non-binding on the board and the company, do not overrule any decision of the board, do not change any board fiduciary duty or create any new fiduciary duty of the board and do not restrict the ability of shareholders to propose other proxy votes relating to executive compensation.
- By the terms of the Act, the say-on-pay provision takes effect without any SEC action. It is possible, however, that the SEC could issue rules governing the form of say-on-pay disclosures in company voting materials. It is also expected that the SEC will amend its rules so that inclusion of the new required votes does not trigger a requirement to file preliminary proxy materials.
- The say-on-parachutes provision covers "any type of compensation (whether present, deferred, or contingent) that is based on or otherwise relates" to an acquisition transaction, raising the question of whether even de minimis executive retention awards or continuity agreements will require a shareholder vote. The Act provides that the say-on-parachute vote is not required where the relevant arrangements have previously been subject to a say-on-pay vote. Whether or not a say-on-parachute vote is required, companies will be required to provide enhanced disclosure regarding compensation related to the transaction under rules to be issued by the SEC. There is no timeline given for these rules, but the Act requires say-on-parachute votes for approvals of transactions occurring after January 21, 2011.
- The Act provides that the SEC may issue rules or orders to exempt issuers or classes of issuers from the rules. The Act directs the SEC to consider whether the say-on-pay and say-on-parachute requirements disproportionately burden small issuers.
- Large institutional investment managers that are subject to reporting under Section 13(f) of the Exchange Act must disclose how they vote on say-on-pay or say-on-parachute matters.
Compensation Committee Independence and Responsibilities. The Act directs the SEC, within 360 days of enactment, to require the exchanges to adopt listing standards requiring greater independence for compensation committees and promoting independence and oversight of compensation committee consultants, legal counsel and other advisers. The SEC and the exchanges will be able to issue exemptions if they find them appropriate.
- The SEC will define independence for the purposes of these new standards. In defining compensation committee member independence, the Act requires the SEC to consider all sources of the committee member's compensation, including compensation from consulting and advising activities, and whether the board member is affiliated with the company, a subsidiary of the company or an affiliate of a subsidiary of the company. The SEC may exempt a relationship from consideration, taking into account the size of the company and any other relevant information.
- According to the Act, the factors to be considered for determining the independence of compensation committee consultants, legal counsel and other advisers must be "competitively neutral." The SEC must consider whether the consultant provides other services to the company, the amount of fees the employer of the consultant receives from the company, the policies of the employer designed to prevent conflicts of interest, business and personal relationships between the consultant and the members of the compensation committee and any company stock the consultant owns.
- The Act provides that the new standards should not be construed to require the committee to follow the recommendation of any compensation consultant or to constrain the committee from exercising its own judgment in fulfilling its duties. Although the Act requires compensation committees to take into account the independence of attorneys and other advisers and permits them to hire independent advisers, it does not prohibit their employing attorneys or other advisers who are not "independent."
- In any proxy statement or material sent for a shareholder meeting occurring after July 21, 2011 (one year after the enactment of the Act), the company must disclose whether the compensation committee retained a compensation consultant, whether any conflicts of interest arose, and, if so, how the conflicts were addressed.
- The SEC will conduct a study within two years of the passage of the Act about the use of compensation consultants and the effect of their use.
Internal Pay Equity. The SEC will require companies to disclose the median annual total compensation of all employees, except the CEO, in comparison to the CEO's annual total compensation. The Act requires that employee compensation for this purpose must be determined in accordance with Regulation S-K Item 402 (the SEC's frequently-amended executive compensation disclosure rule) "as in effect on the day before the date of enactment," i.e., on July 20, 2010. This provision will theoretically require companies to undertake a summary compensation table style analysis for all employees. This provision may also require ongoing reference to the current S-K Item 402 to make the required internal pay equity disclosures. In any event, the requirement to apply the S-K Item 402 calculation of total compensation to all company employees is likely to present significant logistical challenges for many companies. Finally, it is unclear which filings must contain this disclosure, as a literal reading of the Act would require it in many filings, including every Form 10-Q.
Executive Compensation and Financial Performance. The Act requires the SEC to issue a rule requiring companies to provide disclosures, which may include a chart, comparing the compensation paid to executives with the company's stock performance. The time period covered by this disclosure is not specified by the Act.
Clawbacks. The Act will require stock exchange listing standards to require listed companies to adopt incentive compensation clawback policies, under which, in the case of accounting restatements due to material financial reporting non-compliance, the company may recover erroneously awarded incentive compensation received by current and former executive officers during the three years prior to the requirement to restate. The Act does not set a time frame in which these incentive compensation clawback listing standards must be adopted. Companies will also have to disclose to their shareholders their policy on incentive-based compensation that is based on financial information required to be reported under the securities laws.
Limit on Unsafe and Unsound Compensation for Financial Institutions. The law will also require a joint group of federal regulators to issue regulations requiring financial institutions with assets of at least $1 billion to disclose their incentive-based compensation structures to the appropriate regulator and prohibiting compensation structures that the regulators determine encourage inappropriate risks by providing excessive compensation or that could lead to material financial loss.
Other Disclosure Requirements
Independent Board Chairs. The Act requires the SEC, by January 17, 2011 (180 days after the Act's enactment), to issue regulations requiring companies to disclose in proxy materials why they have chosen to have the CEO serve as chair of the board of directors, or not. The SEC issued rules to this effect in December 2009, so it is unclear what further action will be required by this provision.
Hedging Company Securities. The SEC must issue a rule requiring companies to disclose in proxy statements whether directors and employees (not just executives) are allowed to hedge against losses in the value of their company's securities. Companies may wish to review the hedging prohibitions (if any) in their insider trading policies in advance of this rulemaking.
Among the vast number of other provisions in the 848-page law, the Act:
- permanently exempts issuers that are not "large accelerated filers" or "accelerated filers" (defined in Exchange Act Rule 12b-2) from the requirement in Section 404(b) of the Sarbanes-Oxley Act to obtain annual audits of internal control over financial reporting. The SEC and the Government Accountability Office must also conduct studies to determine how the SEC could reduce the burden of Section 404 compliance for larger filers and the impact of the Act's amendment of Section 404.
- addresses the authority of the SEC to treat "security-based swaps" as equity securities for purposes of beneficial ownership reporting under Section 13 of the Exchange Act and the short swing profits provisions of Section 16 of the Exchange Act. This section precludes the SEC from treating such swaps as beneficially owned equity securities, unless it finds the swaps provide incidents of ownership comparable to direct ownership of the underlying equity security, and it is necessary to treat them the same as the underlying security to achieve the purposes of Section 13.
- authorizes the SEC to shorten from the current 10 days the time period in which persons or groups that acquire more than 5% of a company's equity securities must disclose the acquisition, and also the time period within which a person who becomes subject to Section 16 reporting must file an initial Form 3 report of beneficial ownership.
- requires disclosures to the SEC by companies that use in their products so-called "conflict minerals" produced in the Democratic Republic of the Congo—many of which are used in the production of electronic equipment such as cellphones, laptops and medical devices—that are considered to be financing conflict and human rights abuses in the Congo and adjoining countries.
- amends the Sarbanes-Oxley Act's whistleblower cause of action to make clear that consolidated subsidiaries or affiliates of an issuer, as well as the issuer itself, are covered, and creates a program to pay whistleblowers a portion of monetary sanctions recovered by the SEC in enforcement actions.
The Act also contains special disclosure and compliance provisions relating to mine safety and payments to foreign governments by resource extraction companies. It also requires the SEC to eliminate an exemption for communications to credit ratings agencies from Regulation FD restrictions on selective disclosure of material non-public information, and it voids the SEC's Rule 436(g), which exempted certain credit ratings that were included in registration statements from expert liability under the Securities Act.
Companies engaging in private placements under Regulation D should also note that the definition of "accredited investor" has been revised so that the net worth test applicable to natural persons now excludes the value of the person's primary residence. This change is effective immediately.
The Act requires or permits hundreds of rulemakings, studies and reports, including the following key corporate governance, executive compensation and disclosure rules:
Credit Ratings Agencies Exemption from Regulation FD (§ 939B)
October 19, 2010
Independent Board Chairs (§ 972)
January 17, 2011
Payments by Resource Extraction Issuers (§ 1504)
April 17, 2011
Conflict Minerals (§ 1502)
SEC, subject to input as to various matters by other agencies
April 17, 2011
Limit on Unsafe and Unsound Compensation (§ 956)
Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Board of Directors of the Federal Deposit Insurance Corporation, the Director of the Office of Thrift Supervision, the National Credit Union Administration Board, the SEC and the Federal Housing Finance Agency
April 21, 2011
Compensation Committee Independence (§ 952)
July 16, 2011
Beneficial Ownership Definition to Include "Security-Based Swaps"
SEC, after consultation with Secretary of the Treasury and prudential regulators
Broker Discretionary Voting
Clawbacks (§ 954)
Executive Compensation and Financial Performance (§ 953)
Hedging Company Securities
Internal Pay Equity (§ 953)
Mine Safety Disclosures (§ 1503)
Proxy Access (§ 971)
Say-on-Parachutes (§ 951)
Say-on-Pay (§ 951)
Timing of Schedule 13D and Section 16 Reporting (§ 929R)
*This memorandum was prepared with the assistance of summer associate Lesley Fredin.