United States: Preparing For The 2014 Proxy And Annual Reporting Season

Keywords: 2014, proxy statements, annual report, public companies

While the proxy and annual reporting season for calendar year public companies typically heats up in the winter, by autumn preparations for the 2014 season should be underway. The following key issues for the upcoming season are discussed below:

• Current Say-on-Pay Considerations
• Say-When-on-Pay
• Compensation Committee Independence and Compensation Consultants
• NYSE Quorum Requirement Change
• Pending Dodd-Frank Regulation
• Proxy Access
• Specialized Disclosures
• SEC Interpretations Impacting Reporting
• Iran Sanctions Disclosure
• XBRL
• PCAOB Audit Committee Communications Requirements
• Director and Officer Questionnaires
• E-proxy

Current Say-on-Pay Considerations

Public companies now have three years of mandatory say-on-pay voting experience and proxy disclosure precedents to draw upon when drafting say-on-pay proposals for their proxy statements. The say-on-pay requirement makes a clear, user-friendly explanation of compensation very valuable. The compensation discussion and analysis (CD&A) section of the proxy statement, which often begins with an executive summary of the executive compensation program, is a key component of the say-on-pay process. Some companies also have used proxy statement summaries and supporting text within the say-on-pay section of the proxy statement to succinctly highlight the reasons why they believe their executive compensation programs should be approved.

In addition to the proxy disclosure that is part of the say-on-pay proposal itself and the general requirements to explain compensation decisions in the CD&A, companies specifically need to discuss in the CD&A the extent to which compensation decisions were impacted by the results of the say-on-pay vote. There are now two years of precedents for this specific CD&A disclosure that companies may wish to review, both from a disclosure perspective and to benchmark what actions comparable companies have taken in response to say-on-pay votes in terms of shareholder engagement and compensation changes. Compensation committees should be reminded of this reporting obligation so that their deliberations can, if they so choose, specifically address the results of the say-on-pay advisory vote. However, because the say-on-pay vote is non-binding, compensation committees are not compelled to take any actions in response to the shareholder advisory vote.

Before filing the proxy statement and commencing the proxy solicitation, companies should be satisfied that the various sections of the proxy statement adequately explain executive compensation and make the case for approval.

If desired, however, separate additional proxy materials, focusing only on the say-on-pay vote, may be prepared and filed with the Securities and Exchange Commission (SEC) as additional definitive proxy soliciting materials. For example, in the event that a proxy advisory firm recommends that its clients vote against a company's executive compensation, the company may want to prepare letters, presentations or scripts, further explaining its compensation decisions and rebutting the report containing the negative recommendation. Companies do not have to prepare special materials to respond to a negative say-on-pay proxy recommendation, but any such materials a company wishes to use must be filed with the SEC as additional definitive proxy soliciting materials.

A negative recommendation on executive pay from a proxy advisor will not necessarily result in a failed say-on-pay vote. There are precedents for companies receiving majority approval for their say-on-pay proposals even when a proxy advisory firm recommends votes against them, but it is likely that a negative recommendation will at least result in a lower percentage of approval. A say-on-pay proposal receiving significant opposition may have consequences for the company even if the advisory proposal is approved by a majority of the votes cast. For example, if a say-on-pay proposal is approved by less than 70% of the votes cast, ISS has in the past taken that fact into consideration in the subsequent year to determine whether or not to recommend a vote against the management sayon- pay proposal and the election of compensation committee members. In making its decision, ISS has indicated it will consider the company's response, including engagement with major institutional investors, whether the issues are recurring or isolated, the company's ownership structure and whether the say-on-pay vote received the support of less than 50% of the votes cast.

Shareholders, for the most part, approved their companies' executive compensation proposals in 2013, often by wide margins. Of the Russell 3000 companies that held say-on pay votes between January 1, 2013 and September 2, 2013, 91% had their proposals passed with over 70% approval; 77% had approval rates of over 90%; and only 2.45% had their say-on-pay proposal fail.¹

Companies should be aware that there have been several waves of litigation arising out of say-onpay and proxy compensation disclosure. In the first wave, lawsuits were filed against a number of companies and their boards of directors where say-on-pay proposals failed to garner majority approval, alleging breaches of fiduciary duty. Subsequently there were suits alleging insufficient compensation disclosures in the proxy statements, seeking to enjoin the shareholder vote unless the company provided additional compensation disclosures. There have also been lawsuits challenging specific compensation actions, for example, based on failure to comply with Section 162(m) of the Internal Revenue Code. In addition to filed lawsuits, plaintiffs' law firms have also announced "investigations" of executive compensation at a number of companies.

Even if plaintiffs are unsuccessful with their executive pay-related lawsuits, the costs of litigation can be expensive and may hurt the reputations of the defending companies and their compensation committee members and they may also be distracting to management. While many of these suits failed to prevail on the merits, there have been some victories for the plaintiffs, so public companies need to be aware of the potential for compensation-related lawsuits to be brought in connection with the 2014 proxy season. Compensation disclosures should be prepared, and compensation decisions should be made, with care, especially for companies that anticipate resistance to their say-on-pay proposals.

Outreach to key investors can be an important element of a successful say-on-pay vote. Before the proxy season gets fully underway, it would be worthwhile for the investor relations department to contact any large shareholders that voted against executive compensation at the last annual meeting to discuss the reasons for the negative vote. In order to avoid potential violations of the proxy rules, this dialogue should deal with the investor's concerns, and should not involve any solicitation for the upcoming say-on-pay vote.

Say-When-on-Pay

Because the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) only requires companies to hold an advisory vote on the frequency of say-on-pay proposals (often called a "say-when-on-pay" vote) once every six years, it is likely that few companies will include a say-when-on-pay proposal in their 2014 proxy statements.

However, any company that has a management-sponsored say-when-on-pay proposal in its proxy statement must disclose the policy it adopts regarding the frequency of say-on-pay votes— after taking into account the shareholder advisory say-when-on-pay vote—no later than 150 calendar days after the annual meeting, but at least 60 calendar days prior to the company's deadline for submission of shareholder proposals under Rule 14a-8 for the next annual meeting. This disclosure would generally be accomplished in the Form 8-K reporting voting results pursuant to Item 5.07 (or in an amendment to that filing).

Compensation Committee Independence and Compensation Consultants

In June 2013, the SEC approved the compensation committee listing standards contemplated by Dodd-Frank and Rule 10C-1 under the Securities Exchange Act of 1934 (Exchange Act). The new listing standards establish independence requirements for compensation committee members and require compensation committees to consider factors relevant to potential conflicts of interest on the part of compensation consultants, legal advisers and other compensation advisers. The NYSE and Nasdaq rules are similar in many respects, but are discussed separately below for convenience.

NYSE REQUIREMENTS

NYSE Compensation Committee Independence Requirements. The NYSE added new subsection (ii) to Section 303A.02(a) of the NYSE listed company manual to address the enhanced independence requirements for compensation committee members. This new independence rule specifies that, in addition to existing requirements to determine the independence of any director who will serve on the compensation committee, the board of directors must consider:

With respect to compensation, the accompanying commentary makes clear that the board "should consider whether the director receives compensation from any person or entity that would impair his ability to make independent judgments about the listed company's executive compensation." The rule does not expressly require consideration of indirect compensation, such as compensation paid to a family member or to a related entity, but such compensation may need to be considered to the extent that it is relevant to determining whether a director has a relationship that is material to his or her ability to be independent from management. Unlike the Nasdaq rules discussed below, the NYSE listing rule does not make receipt of any type of compensation a bar to serving on the compensation committee if the board is satisfied that such director meets the requirements for independence.

Similarly, affiliate status is not a bar to compensation committee independence under the NYSE listing standards. The commentary directs boards of directors to consider whether an affiliate relationship places a director under the direct or indirect control of the company or its senior management—or creates a direct relationship between the director and members of senior management—of a nature that would impair the director's ability to make independent judgments about the listed company's executive compensation.

NYSE Compensation Adviser Requirements. The NYSE added new subsection (c) to Section 303A.05 of the NYSE listed company manual to specify the rights and responsibilities of the compensation committee with respect to compensation advisers, which now must be addressed in the compensation committee charter. These provisions give the compensation committee the sole discretion to retain or obtain the advice of a compensation consultant, independent legal counsel or other adviser. When the compensation committee retains such an adviser, it is directly responsible for appointing, compensating and overseeing the adviser's work. The company must provide for appropriate funding, as determined by the compensation committee, for payment of reasonable compensation to an adviser retained by the compensation committee.

The compensation committee may select a compensation consultant, legal counsel or other adviser only after considering all factors relevant to independence from management, including the following:

• The provision of other services to the company by the person that employs the compensation adviser;
• The amount of fees received from the company by the employer of the adviser, as a percentage of the total revenue of such employer;
• The policies and procedures of the adviser's employer that are designed to prevent conflicts of interest;
• Any business or personal relationship of the adviser with a member of the compensation committee;
• Any stock of the company owned by the adviser; and
• Any business or personal relationship of the adviser or the adviser's employer with an executive officer of the company.

The NYSE listing standard requires consideration of all factors relevant to compensation adviser independence, not just the six factors enumerated above. If there is a circumstance that is relevant to determining whether a compensation adviser is independent from management, the compensation committee would need to consider it, regardless of whether it is included among the specific factors mentioned in the listing standards.

The compensation committee is required to conduct the independence assessment for any compensation consultant, legal counsel or other adviser that provides advice to the compensation committee, other than:

• In-house legal counsel; and
• Any compensation consultant, legal counsel or other adviser whose role is limited to:
  
  
  • consulting on any broad-based plan that does not discriminate in scope, terms or operation, in favor of executive officers or directors of the listed company, and that is available generally to all salaried employees; or
  • providing information that either is not customized for a particular company or that is customized based on parameters that are not developed by the compensation consultant, and about which the compensation consultant does not provide advice.

In its order approving the NYSE's amended listing standards, the SEC stated that it "anticipates that compensation committees will conduct such an independence assessment at least annually."

When adopting Rule 10C-1, the SEC emphasized that compensation committees are required to conduct this conflict of interest assessment regardless of whether the compensation committee or management retained the adviser.

The NYSE commentary makes clear that the listing standards relating to compensation advisers do not require the compensation committee to act consistently with the advice or recommendation of any compensation adviser. Furthermore, the commentary states that the new listing standards do not require a compensation adviser to be independent. The requirement is that the compensation committee must consider the enumerated independence factors before selecting or receiving advice from a compensation adviser. However, after considering these independence factors, the compensation committee may select or receive advice from any compensation adviser it prefers, including ones that are not independent.

NYSE Effective Dates.The amended NYSE listing standards are effective, but NYSE listed companies have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the new compensation committee independence requirements.

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Originally published September 26, 2013

Footnote

1 See Semler Brossy "2013 say on pay results," September 4, 2013, available at http://www.semlerbrossy.com/wpcontent/uploads/2013/09/SBCG-2013-Say-on-Pay-Report-2013-09-4.pdf.

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