United States: Dodd-Frank Wall Street Reform and Consumer Protection Act: Impact on Public Companies

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") was approved by the House on June 30, 2010, and by the Senate on July 15, 2010. The bill is expected to be signed into law by President Obama. Although the Dodd-Frank Act generally addresses financial regulatory reform there are a number of provisions relevant to public companies with respect to corporate governance, executive compensation, disclosure and other matters. Below is a brief summary of the key provisions applicable to public companies.

I. Shareholder Advisory Votes on Executive Compensation

Say-on-Pay. The Dodd-Frank Act would require issuers to hold a separate, nonbinding shareholder vote (commonly known as a "say-on-pay" vote) at least once every three years to approve all named executive officer compensation for which disclosure is required under rules issued by the Securities and Exchange Commission (the "Commission") . This provision would constitute an expansion of the say-on-pay regime, which currently requires TARP companies to hold say-on-pay votes annually. The Dodd-Frank Act would require, in addition, a separate shareholder vote at least once every six years to determine whether say-on-pay votes should be held every one, two or three years. The say-on-pay requirements would apply to annual proxy meetings that take place six months or more after the date the Dodd-Frank Act is enacted.

Golden Parachute Payments. In any proxy or solicitation materials in which shareholder approval is sought for an acquisition, merger, consolidation, or proposed sale or other disposition of all or substantially all of the assets of an issuer, all compensation payable to named executive officers in connection with the event and all agreements and understandings that the soliciting person has with the named executive officer concerning such compensation would have to be disclosed and submitted to a separate nonbinding vote of shareholders. If the compensation and agreements have already been approved by a previous say-on-pay vote, then a separate golden parachute say-on-pay vote is not required.

Disclosure of Votes. Institutional investors subject to reporting pursuant to Section 13(f) of the Securities Exchange Act of 1934, as amended (the "1934 Act"), will have to report at least annually how they voted on any of the say-on-pay votes or golden parachute payment votes. The Commission may exempt individual issuers or classes of issuers from required say-on-pay votes, taking into account, in particular, whether the requirements disproportionately burden small issuers.

Proxy Access. The Dodd-Frank Act provides the Commission with the authority to promulgate rules granting shareholders the ability to require the shareholders' director nominations in their company's proxy solicitation materials. Although the Commission is not required to adopt such rules, this provision of the Dodd-Frank Act clarifies the Commission's ability to so do, and it grants the Commission broad discretion to formulate rules without required ownership mandates for access rights.

II. Compensation Committees

Independence. The Dodd-Frank Act would require the Commission to direct the national securities exchanges and associations (the "Exchanges") to prohibit the listing of any equity securities of any issuer that did not have a compensation committee comprised entirely of independent directors. Independence will be determined under rules to be established by the applicable exchange. The Commission rules also require the Exchanges to consider, in determining the definition of independence, (i) the source of director compensation, including any consulting, advisory or other compensatory fees paid to the director by the issuer and (ii) whether the director is affiliated with the issuer or its subsidiaries. This requirement would not apply to specified issuers, including "controlled companies" and certain foreign private issuers.

Compensation Committee Advisors. Compensation committees would have the authority to retain, and would be solely responsible for the appointment, compensation and oversight of compensation consultants and independent legal counsel and other advisors. Issuers would have to provide appropriate funding for the payment of reasonable compensation to a compensation consultant, independent legal counsel or other advisor. In any proxy statement issued one year or more after the date the Dodd-Frank Act is enacted, an issuer would have to disclose whether its compensation committee received the advice of a compensation consultant, whether the work of the compensation consultant raised any conflicts of interest and, if so, what the conflicts were and how they were addressed.

Compensation committees would also have to take into account certain "independence" factors when selecting compensation consultants, legal counsel and other advisors. These factors would be identified by the Commission, but would include:

  • Other services provided by the advisor to the issuer;
  • The fees the advisor received from the issuer as a percentage of the advisor's total revenue;
  • The advisor's conflict of interest policies;
  • The advisor's business and personal relationships with members of the compensation committee; and
  • Stock of the issuer owned by the advisor.

III. Clawbacks

The Dodd-Frank Act would direct the Commission to adopt rules requiring issuers to adopt and disclose clawback policies and to prohibit the listing of any securities of issuers that do not implement such policies.

The required clawback would apply in the event of an accounting restatement resulting from material noncompliance with financial reporting requirements under the securities laws. Issuers would be required to recover from any current or former executive officer who received incentive-based compensation (including stock options) within the three-year period prior to the restatement the amount in excess of what they would have been paid under the restatement.

The Dodd-Frank Act would thus expand on the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley"), which requires the adoption of clawback policies only with respect to chief executive officers and chief financial officers and only in limited circumstances.

IV. New Disclosure Requirements

Executive Compensation. The Dodd-Frank Act would require the Commission to adopt rules requiring issuers to disclose in their proxy statements information reflecting the relationship between executive compensation and issuer financial performance, taking into account changes in share value, dividends and distributions, and would allow for graphic representation of such information. Although Item 402 of Regulation S-K currently requires discussion of these topics in the Compensation Discussion & Analysis, the Dodd-Frank Act would require specific quantitative disclosure.

In addition, the Dodd-Frank Act would require disclosure of:

  • Median annual total compensation for all employees of the issuer except the chief executive officer;
  • Annual total compensation of the chief executive officer; and
  • The ratio of median annual total compensation for all employees to annual total compensation of the chief executive officer.

Employee and Director Hedging. The Dodd-Frank Act would direct the Commission to adopt rules requiring issuers to disclose in their proxy statements whether any employee or director (or any designee of any employee or director) is permitted to purchase financial instruments designed to hedge or offset any decrease in the market value of equity securities granted as compensation or held by such employee or director, directly or indirectly.

Chairman and CEO Structure. The Dodd-Frank Act would direct the Commission to adopt, no later than 180 days after the bill's enactment, rules requiring an issuer to disclose in its proxy statement the reasons why its board chairman and chief executive officer positions are held either by the same person or by different persons, as the case may be. The enhanced executive compensation regulations in Item 402 of Regulation S-K adopted in December 2009 already require disclosure of the company's board leadership structure and a discussion regarding why the company determined that such structure was appropriate.

Covered Financial Institutions. The Dodd-Frank Act would direct regulators of covered financial institutions to prescribe, within nine months of the bill's enactment, regulations or guidelines requiring covered financial institutions with assets of $1 billion or more (including depository institutions, holding companies, broker-dealers, credit unions, investment advisors, the Federal National Mortgages Association, the Federal Home Loan Mortgage Corporation and any other institution designated by the regulators) to disclose the structure of all incentive-based compensation arrangements. The Dodd-Frank Act would also require that such rules and guidelines prohibit covered financial institutions from maintaining any incentive-based compensation arrangements that encourage inappropriate risk-taking by providing excessive compensation, fees or benefits or that could lead to material financial loss to the institution.

Conflict Minerals. The Dodd-Frank Act proposes regulation of specific minerals obtained from sources in the Democratic Republic of Congo and bordering countries (the "Countries"), which include "columbite-tantalite (coltan), cassiterite, gold, wolfamite, or their derivatives" and certain other minerals (the "Conflict Minerals"). In particular, the Dodd-Frank Act requires the Commission to enact additional rules requiring enhanced disclosure regarding issuers for which the use of the minerals is "necessary" with respect to the issuers' business, including:

  • Annual disclosure regarding whether the Conflict Minerals are sourced from the Countries;
  • When the Conflict Minerals originate from the Countries, the issuers must provide a report to the Commission describing the "due diligence on the source and chain of custody" of the Conflict Minerals undertaken by the company, including an independent audit of such procedures; and
  • Disclosure regarding whether certain Conflict Minerals used by such issuers are "DRC conflict free," meaning that the minerals used do not "finance or benefit armed groups" in the Countries.

The new disclosure must be required by the Commission within 270 days of the Dodd-Frank Act's enactment, and will terminate at least five years from such enactment, upon the date that the U.S. President determines that no armed groups continue to benefit from the Conflict Minerals.

Resource Extraction. The Dodd-Frank Act requires that, within 270 days of enactment, the Commission must promulgate rules relating to issuers that engage in "resource extraction," meaning the "commercial development of oil, natural gas, or minerals," including annual disclosure of payments made by the company or its subsidiaries to foreign governments or the U.S. federal government related to such extraction.

Mine Operation. The Dodd-Frank Act requires, within 30 days of enactment, enhanced disclosure for issuers that operate coal or other mines, including:

  • The inclusion of certain items related to mine safety in the issuers' periodic reports; and
  • The filing of a Form 8-K with the Commission when and if the company receives from regulatory bodies certain safety notices, including the receipt of an "imminent danger order" under the Federal Mine Safety and Healthy Act of 1997 and the receipt of a written notice from the Mine Safety and Health Administration regarding a pattern of health and safety violations or the potential for such a pattern.

Determination of Beneficial Ownership and Short Sale Disclosure. The Dodd-Frank Act also provides for amendments to Sections 13 and 16 of the 1934 Act, including:

  • The Commission, only upon consultation with the prudential regulators (including institutions that regulate, or the board of directors of, certain swap dealers and major swap participants) and the Treasury Secretary, may determine that the purchase of a security-based swap (as the Commission may define by rule) constitutes beneficial ownership of the underlying equity security for purposes of Sections 13(d), 13(f) and 16(a).
  • The Commission may adopt rules requiring a period shorter than 10 days following an acquisition for the filing of an initial Section 13(d) report and the time a person becomes a director, officer or beneficial owner for the filing of an initial Section 16(a) report.
  • The Commission must adopt rules requiring monthly disclosure of short positions by Section 13(f) filers.

V. Internal Controls and Sarbanes-Oxley

Issuers that are not considered "large accelerated filers" or "accelerated filers" would now be exempt from the requirement of Sarbanes-Oxley to provide an external audit of internal controls. In addition, the Commission would be required to conduct certain studies relative to Section 404(b) of Sarbanes-Oxley, including its impact on issuers with market capitalization between $75 million and $250 million.

VI. Whistleblowers

The Dodd-Frank Act provides for amendments to the 1934 Act designed to provide incentives to and protect whistleblowers. For a more detailed discussion of these changes, see "New Incentives for Foreign Corrupt Practices Act Whistleblowers: Dodd-Frank Wall Street Reform and Consumer Protection Act."

VII. Broker Discretionary Voting

The Dodd-Frank Act requires the Commission to issue new regulations prohibiting brokers from discretionarily voting their clients' securities held in street name with respect to the election of directors, executive compensation or "any other significant matter," as determined by the Commission, including say-on-pay and golden parachute-related voting, unless the beneficial owner has provided the broker with voting instructions.

VIII. Non-U.S. Issuers

Certain of the Dodd-Frank Act's provisions apply to foreign private issuers, including those involving beneficial ownership reporting, whistleblower protection and broker discretionary voting. However, those provisions implemented through the U.S. proxy rules, including say-on-pay and golden parachute payments, executive compensation and hedging disclosure, chairman and CEO structure and proxy access will not apply to foreign private issuers. In addition, foreign private issuers that disclose their reasons for not having an independent compensation committee are exempt from the compensation committee rules. Finally, it is not yet certain whether the Dodd-Frank Act's clawbacks provisions will provide an exception for non-U.S. companies when implemented.

* * * * * * * * * *

The precise impact of many of the changes to the rules and regulations applicable to public companies will not be known until the Commission adopts new regulations on the matters required by the Dodd-Frank Act. Nevertheless, the Dodd-Frank Act is another example of the increased scrutiny that public companies have faced over the past several years, particularly with respect to executive compensation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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