Several regulatory developments will affect US public companies for the 2011 proxy solicitation and annual meeting season. In particular, public companies will need to hold shareholder advisory votes on two executive compensation-related proposals at their 2011 annual meetings - "Say on Pay" and "Say on Frequency."  The SEC has not yet adopted final rules regarding Say on Pay or Say on Frequency; nonetheless, the requirements to hold shareholder advisory votes on these matters apply to annual or other shareholder meetings held on or after January 21, 2011.

The good news for the 2011 proxy solicitation and annual meeting season is that the SEC has stayed the effective date of its "proxy access" rules in light of pending federal court review of those rules.  The proxy access rules would have required public companies, under certain circumstances, to include in their proxy statements information about, and an ability to vote for, shareholder-nominated director candidates.

Say on Pay

Public companies are required to submit a non-binding Say on Pay proposal for a shareholder vote at least once every three years, starting with a company's first shareholder meeting held on or after January 21, 2011.  The vote relates to the compensation of a company's "named executive officers" and is an advisory vote only - the outcome does not negate or otherwise change compensation decisions made by the compensation committee or board of directors.  From a disclosure standpoint, the outcome of the Say on Pay vote is largely prospective - future Compensation Discussion and Analysis (CD&A) disclosure will be required to address how the company's decisions regarding compensation and compensation policies have taken into account the results of prior Say on Pay votes.

The proposed rule does not mandate the use of any specific language in the proxy for the Say on Pay proposal.  The disclosure, however, is required to make it clear that the vote covers all of the executive compensation required to be disclosed in the proxy statement, including the CD&A and narrative and tabular disclosure required by Regulation S-K Item 402.  This means that the vote cannot be limited so as to apply only to discrete elements of compensation, such as the company's compensation policies (unless there are multiple votes that, taken together, cover all elements of named executive officer compensation).  In addition, the Say on Pay proposal need not cover practices relating to risk management or risk taking incentives generally relating to company employees.  However, to the extent that risk considerations are discussed in the CD&A because they are a material component of executive compensation policies or determinations, those risk considerations would be deemed to be part of the Say on Pay proposal.

The proposed rule also mandates that the disclosure address why the Say on Pay proposal is being submitted to shareholders (i.e., because it is required under Section 14A of the Exchange Act) and the effect of the shareholder vote, including disclosure making it clear that the vote is non-binding.

Say on Frequency

Public companies also must submit a non-binding Say on Frequency proposal for a shareholder vote at least once every six years, starting with a company's first shareholder meeting held on or after January 21, 2011.  This proposal allows shareholders to vote on how frequently a Say on Pay proposal will be submitted for a shareholder vote - every year, every second year or every third year.  As is the case with Say on Pay, the Say on Frequency vote is an advisory vote only and is not binding on the company.

This proposed rule also does not mandate the use of any specific language in the proxy for the Say on Frequency proposal.  The disclosure, however, is required to make it clear that shareholders have a choice among four different alternatives for the frequency of Say on Pay votes - annual, biennial, triennial and abstain from voting.  This "multiple choice" element means that shareholders will be permitted to express a specific preference as to the frequency of Say on Pay proposals rather than simply being given the opportunity to approve or disapprove the company's recommendation regarding frequency. As is the case with Say on Pay, the Say on Frequency disclosure also must address why the proposal is being submitted to shareholders and the effect of the shareholder vote, including disclosure making it clear that the vote is non-binding.  In addition, the company must provide disclosure of its decision regarding vote frequency in light of the advisory vote in its Form 10-Q covering the period during which its annual meeting took place (or in its Form 10-K if the vote was held in the company's fourth quarter).  A company may also voluntarily include this disclosure in the Form 8-K it files to report the results of the votes taken at the meeting pursuant to Item 5.07 of that form.

Public companies and their boards of directors must decide if they will make a recommendation to shareholders regarding frequency and, if so, what that recommendation will be.  No recommendation is required, but we expect that most boards will choose to include one and explain in some detail their reasons for preferring one frequency choice over the others.  The choice of a one, two or three year recommendation will be affected by a number of factors, both external and internal, including:

  • Preferences expressed by key company shareholders.
  • Voting policies and recommendations of institutional shareholders and proxy advisory firms (e.g., Institutional Shareholder Services recommends that Say on Pay votes occur annually; some institutional investors have supported a triennial schedule).
  • Recommendations made/policies adopted by peer companies.
  • Prior experience with shareholder proposals regarding executive compensation.
  • Desire to match the vote frequency with key compensation elements (e.g., triennial voting may be more appropriate for companies with performance incentive plans based on multi-year metrics).
  • Desire to allow the board of directors sufficient time to analyze Say on Pay vote results, engage further with shareholders after a vote, and plan for and implement changes to compensation practices.

If the board of directors chooses to make a recommendation, the accompanying disclosure must make it clear that the shareholder vote is not a vote to adopt/reject the board's recommendation, but to choose either a one, two or three year frequency (or abstain from so choosing).  The proposed SEC rule does not provide a specific standard for determining how a frequency choice "wins" - by receiving a plurality, majority or super-majority vote - but if the company adopts a frequency policy consistent with the choice selected by a plurality of the votes cast, then it may exclude any future shareholder proposals seeking a more-frequent (or less-frequent) Say on Pay vote.

Some Drafting Suggestions

Because of the importance of the Say on Pay and Say on Frequency votes this year, it is critical that the proxy statement disclosure clearly articulate the company's compensation philosophy, describe the elements of compensation, and provide the reasons for making the Say on Pay and Say on Frequency recommendations.  A variety of factors have worked together to generally make compensation-related disclosures some of the least user-friendly sections of public companies' disclosure documents.  This year, however, a company's ability to make its compensation-related disclosures digestible may prove to be the difference between obtaining and not obtaining the company's desired results.

Achieving this goal necessitates a shift in approach, from a compliance-based focus that emphasizes the line-item requirements of the SEC's rules to an approach that combines marketing and ease-of-use elements.  It is important to keep in mind that this will be the first time many shareholders will be considering these types of proposals.  In addition, key readers of the proxy statement - the proxy advisory firms and institutional investors - will be reviewing scores of proxy statements.  These factors support adopting an approach that provides readers with well-developed reasons for agreeing with the company's recommendations, while making it easy to identify and assess the key elements of named executive officer compensation and the company's compensation practices.

To this end, companies should consider adding an executive summary at the beginning of the CD&A section.  Like any summary, this executive summary should set the stage for the more comprehensive disclosure presented in the CD&A and elsewhere in the proxy statement, but it should also address, in one place, the compensation topics that are most likely to be relevant to the reader in determining how to vote.  Some suggested elements of the executive summary:

  • A clear explanation and demonstration of the relationship between compensation and performance.
  • An overview of the company's performance during the last year and how that performance affected compensation and decisions made by the board/compensation committee regarding compensation.
  • A discussion of any significant compensation practices that have been implemented or changed in the past year.
  • A discussion of the company's compensation practices that are shareholder-friendly or considered "best practices."

TARP

Companies that received TARP funding are exempt from these Say on Pay and Say on Frequency rules until all of their TARP obligations have been repaid.  TARP already requires these companies to hold annual say on pay votes.

Form 8-K Filing Requirements

Form 8-K requires public companies to make a filing within four business days following the shareholder meeting to report the results of shareholder votes at the meeting.  The results of the votes on the Say on Pay and Say on Frequency proposals must be reported as part of this Form 8-K filing, along with the results of director elections, ratification of accountants and the other matters submitted to a vote at the meeting.

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.