THE PROXY SEASON FIELD GUIDE
The 2017 proxy season occurs in an environment of heightened shareholder activism and an ever-increasing focus on compensation and corporate governance disclosures. This Proxy Season Field Guide provides you with an overview of recent legislative, regulatory and shareholder developments, and provides guidance on how these developments will impact you in the 2017 proxy season.
THE LEGISLATIVE AND REGULATORY DEVELOPMENTS SHAPING THE PROXY SEASON
On July 21, 2010, President Obama signed into law what was called the most sweeping set of financial reforms since the Great Depression, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Dodd-Frank Act"). While this legislation focused principally on changes to the financial regulatory system, several corporate governance and compensation provisions of the Dodd-Frank Act target public companies. The corporate governance and compensation provisions include:
- A requirement that public companies solicit an advisory vote on executive compensation ("Say-on-Pay"), an advisory vote on the frequency of Say-on- Pay votes ("Say-on-Frequency") and, in the event of a merger or other extraordinary transaction, an advisory vote on certain "golden parachute" payments ("Say-on-Golden Parachutes");
- Requirements that the Securities and Exchange Commission ("SEC") adopt rules directing the securities exchanges to adopt listing standards with respect to compensation committee independence and the use of consultants;
- Provisions calling for the SEC to adopt expanded disclosure in the annual proxy statement and other filings, particularly in the area of executive compensation, such as disclosure of pay versus performance, the ratio of CEO pay to the pay of a median employee, and policies with regard to hedging transactions conducted by employees and directors; and
- Provisions that require the adoption or revision of certain other policies, such as compensation recovery policies providing for the recovery of executive compensation in the event of a financial restatement.
The SEC and the stock exchanges have worked to adopt a number of new rules and standards in order to implement the requirements of the Dodd-Frank Act discussed above. While several of the key provisions of the Dodd-Frank Act will be in place for the 2017 proxy season, the future of the Dodd-Frank Act and the provisions applicable to public companies is now uncertain.
The implementation of Say-on-Pay votes was one of the most widely anticipated corporate governance developments in the United States in recent memory. Advocates for Say-on-Pay in the United States hoped that the advisory votes on executive compensation would serve to encourage greater accountability for executive compensation decisions, as well as more focused compensation disclosure in proxy statements and expanded shareholder engagement. In many ways, these objectives have been realized as Say-on-Pay has matured.
The SEC rules for Say-on-Pay provide:
- Issuers must provide a separate shareholder advisory vote in proxy statements to approve the compensation of executives not less than every three years. Shareholders must vote, on an advisory basis, to approve the compensation of the issuer's named executive officers, as such compensation is disclosed under Item 402 of Regulation S-K, including the Compensation Discussion and Analysis ("CD&A"), the compensation tables, and other narrative executive compensation disclosures required by Item 402. The rule does not require issuers to use any specific language or a specific form of resolution; however an Instruction to the Rule provides a non-exclusive example of a form of resolution;
- Issuers must provide a separate shareholder advisory vote in proxy statements for annual meetings to determine whether the vote on the compensation of executives will occur every 1, 2, or 3 years. This Say-on-Frequency vote is required not less frequently than once every six years, meaning that issuers who first solicited Say-on-Frequency votes immediately following adoption after the enactment of the Dodd-Frank Act will now have to seek Say-on-Frequency votes again in the 2017 proxy season;
- Issuers must explain in the proxy statement the general effect of the Say-on- Pay votes (i.e., the vote is non-binding), and also must disclose, when applicable, the current frequency of Say-on-Pay votes and when the next Say-on- Pay vote will occur;
- Say-on-Pay and Say-on-Frequency votes do not trigger the filing of a preliminary proxy statement with the SEC;
- Issuers are able to exclude shareholder proposals that would provide a Sayon- Pay vote, seek future Say-on-Pay votes, or relate to the frequency of Sayon- Pay votes in certain circumstances when, in the most recent Say-on- Frequency vote, a single frequency received a majority of votes cast and the issuer adopted a policy for the frequency of Say-on-Pay votes that is consistent with that choice;
- The CD&A must disclose whether and, if so, how the issuer has considered the results of the most recent shareholder advisory vote on executive compensation in determining compensation policies and decisions and, if so, how that consideration has affected the issuer's compensation decisions and policies; and
- Issuers must report, pursuant to Item 5.07 of Form 8-K, the decision as to how frequently the issuer will conduct its Say-on-Pay votes following each Say-on-Frequency vote. If the information is provided by amendment to the Form 8-K, the amendment is due no later than 150 calendar days after the date of the end of the annual meeting in which the Say-on-Frequency vote occurred, but in no event later than 60 calendar days prior to the deadline for the submission of shareholder proposals for the next annual meeting as disclosed in the proxy materials for the meeting at which the Say-on-Frequency vote occurred.
During the 2016 proxy season, only 36 issuers failed to achieve majority shareholder support for mandatory Say-on-Pay resolutions, the lowest level since 2011. The high level of shareholder support for Say-on-Pay resolutions during the 2016 proxy season was very similar to the experience for issuers that conducted Say-on-Pay votes over the past six years. In the vast majority of those situations, shareholders have provided strong support for Say-on-Pay proposals, absent some significant concerns with the company's executive compensation programs. Even with the likelihood of shareholder support relatively high for Say-on-Pay resolutions, companies have paid very close attention to the message communicated through their CD&A and other disclosures, while at the same time seeking to engage with key shareholder constituencies.
A key agenda item for the compensation committee remains the consideration of the outcome of the most recent Say-on-Pay vote. This is because a "mandatory" CD&A item requires that an issuer must address whether and, if so, how the issuer has considered the results of the most recent Say-on-Pay vote in determining compensation policies and decisions and, if so, how that consideration has affected the company's executive compensation decisions and policies. An issuer that failed to achieve majority support or that received majority support but less than 70%-75% in support for the Say-on-Pay proposal likely needs to make substantial disclosures regarding the engagement efforts that the issuer undertook to understand the reasons for the lack of support, the consideration by the compensation committee of the vote and the results of the engagement efforts, and the specific steps undertaken with the executive compensation program that responded to shareholders' concerns. While the early shareholder engagement efforts were often reactive, recent proxy seasons have been characterized by much more proactive engagement efforts, utilizing "road show" meetings, conference calls, and perhaps even electronic communications to more effectively engage with shareholders.
When drafting the proxy statement for 2017, the same focus on transparency and communicating an effective message that characterized the last few proxy seasons should carry through. It remains critically important for the CD&A to reflect the notable aspects of the compensation policies and decisions, while highlighting the pay-forperformance aspects of compensation plans.
KEY DISCLOSURE CONSIDERATIONS FOR PROXY STATEMENTS AND ANNUAL REPORTS
The SEC Staff (the "Staff") has come to expect that issuers are aware of the interpretive positions taken by the Staff in comment letters on filings, which often reflect nuanced readings of the rules or require more detailed disclosure than might otherwise be expected. It has become increasingly important that issuers make themselves familiar with Staff comment letters that have been issued to other issuers, so that they can respond to the issues raised in those letters when preparing their own filings.
Over the past several years, the SEC has provided significant guidance with respect to its interpretation of executive compensation disclosure rules, including numerous Staff speeches, interpretations and comments on individual filings. There are a number of significant areas of focus in Staff comments and other interpretive guidance on executive compensation disclosure. For example, the Staff has repeatedly stated that an issuer's CD&A should focus on how and why the issuer arrived at specific executive compensation decisions and policies and should address why specific compensation decisions were made. Other principal areas of Staff comment in the CD&A have related to the disclosure of incentive plan performance targets, individual performance goals and benchmarking practices or processes.
Areas of frequent Staff comment in annual reports have addressed disclosure of goodwill impairment charges, loss contingency disclosures, liquidity, debt covenants, non-GAAP financial measures, disclosure controls and procedures, cybersecurity risks, risk factors, restatements and exhibits. Over the past several years, the SEC has also provided interpretive guidance outside of the comment process in several key areas relevant to preparing Form 10-Ks and proxy statements, including guidance on non-GAAP financial measures, the discussion of liquidity and funding risks in the Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A), cybersecurity risks, European sovereign debt exposures, disclosures under Section 13(r) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") and audit committee disclosures.
SHAREHOLDER ACTIVISM AND CORPORATE GOVERNANCE
Continued shareholder concerns over corporate governance and executive compensation issues will shape the outcome of votes in the 2017 proxy season. Issuers will need to continue to focus on voting policies of institutional shareholders and proxy advisory services when making corporate governance and executive compensation decisions. Shareholder proposals in 2016 focused on:
- Proxy access shareholder proposals;
- Compensation-related proposals (i.e., pay-for-performance, clawbacks, compensation consultants, gender pay disparity and conflicts of interest);
- Majority voting for directors (particularly at Russell 3000 companies);
- Shareholder ability to call special meetings and take action by written consent;
- Declassified board of directors;
- Disclosure, limits, board oversight, and shareholder approval or ratification of political contributions and lobbying; and
- Split chairman/CEO proposals.
During the 2016 proxy season, many larger issuers amended their bylaws to permit proxy access. Institutional investors continued an effort to implement universal proxy access through private ordering. Proxy access remains one of the key corporate governance issues for the 2017 proxy season.
Institutional Shareholder Services ("ISS") and Glass Lewis & Co. ("Glass Lewis") released 2017 updates to their U.S. proxy voting guidelines, addressing, among other issues, equity plans, director and executive compensation, director overboarding, governance following an IPO, and restrictions on submission of binding shareholder proposals.
The 2017 proxy season will continue to present challenges for issuers as they seek to obtain strong support for their Say-on-Pay votes, while at the same time remaining attentive to ongoing shareholder concerns regarding corporate governance and executive compensation. This Proxy Season Field Guide will provide you with the resources necessary to successfully navigate the proxy season.
THE LEGISLATIVE AND REGULATORY DEVELOPMENTS SHAPING THE PROXY SEASON
THE LEGISLATIVE AND REGULATORY DEVELOPMENTS SHAPING THE PROXY SEASON
On July 21, 2010, President Obama signed into law what was called the most sweeping set of financial reforms since the Great Depression, the Dodd-Frank Act. The Dodd-Frank Act focuses principally on changes to the financial regulatory system; however, several corporate governance and compensation provisions of the Dodd- Frank Act target public companies. The corporate governance and compensation provisions include:
- A requirement that public companies solicit a Say-on-Pay vote, a Say-on- Frequency Vote and, in the event of a merger or other extraordinary transaction, a Say-on-Golden Parachute vote;
- Requirements that the SEC adopt rules directing the securities exchanges to adopt listing standards with respect to compensation committee independence and the use of consultants;
- Provisions calling for the SEC to adopt expanded disclosure requirements for the annual proxy statement and other filings, particularly in the area of executive compensation; and
- Provisions that will require the adoption or revision of certain other policies, such as compensation recovery policies providing for the recovery of executive compensation in the event of a financial restatement.
To date, a number of the rules and standards called for by the Dodd-Frank Act have not been adopted or fully implemented. In January 2017, SEC Chair Mary Jo White resigned, and Commissioner Michael Piowowar was appointed Acting Chairman. The Trump Administration announced that Jay Clayton, a lawyer at Sullivan & Cromwell, will be appointed SEC Chairman, and his appointment must be confirmed by the Senate. Two other Commissioners will also need to be appointed and confirmed in order for the Commission to be comprised of five Commissioners. Following the November 2016 U.S. election, the Trump Administration, members of Congress and the Acting SEC Chairman Michael Piwowar have indicated that provisions of the Dodd-Frank Act applicable to public companies may be revisited in the coming months. It is unlikely that any of these potential changes will have an immediate impact on the 2017 proxy season. Prior to the 2016 election, Representative Hensarling (R-TX), Chairman of the House Financial Services Committee, introduced The Financial CHOICE Act, a piece of legislation that would repeal or change many provisions of the Dodd-Frank Act. While, like the Dodd-Frank Act, most of the bill focuses on regulation of the financial services industry, portions would address disclosure and governance portions of the Dodd-Frank Act. Among the areas that would be addressed by the legislation would be: (i) the repeal of the specialized disclosure requirements (conflict minerals, mine safety and resource extraction issuer disclosure); (ii) an amendment to the Say-on-Pay requirement so that it would only be required when the issuer has made a material change to the executive compensation package; (iii) the modification of the clawback requirement so that it would only apply to "bad actor" current and former executives who had control or authority over the issuer's financial reporting in the event of a restatement; and (iv) repeal the CEO pay ratio disclosure requirement. The Republicans in the House of Representatives have indicated that they plan to re-introduce this legislation.
ADVISORY VOTES ON EXECUTIVE COMPENSATION
Say-on-Pay and Say-on-Frequency
For larger public issuers, beginning with shareholder meetings occurring on or after January 21, 2011, Section 951 of the Dodd-Frank Act required that issuers include a resolution in their proxy statements asking shareholders to approve, in a nonbinding vote, the compensation of their executive officers, as disclosed under Item 402 of Regulation S-K. A separate resolution is also required to determine whether this Say-on-Pay vote takes place every one, two, or three years.
On January 25, 2011, the SEC adopted rules implementing Say-on-Pay and the related advisory vote on executive compensation provisions. The new rules and amendments to existing rules became effective on April 4, 2011, except that the Sayon- Golden Parachute requirements became effective for filings made on or after April 25, 2011, for all issuers.
A complete description of these rules, rule amendments and applicable SEC and Staff interpretations is provided in Chapter 2.
The applicable rules and rule amendments are as follows:
- Rule 14a-21(a) requires that issuers must provide a separate shareholder advisory vote in proxy statements to approve the compensation of executives not less than every three years. In accordance with Section 14A(a)(1) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), shareholders must vote, on an advisory basis, to approve the compensation of the issuer's named executive officers, as such compensation is disclosed under Item 402 of Regulation S-K, including the CD&A, the compensation tables and other narrative executive compensation disclosures required by Item 402. The rule does not require issuers to use any specific language or a specific form of resolution; however, an Instruction to Rule 14a-21 provides a non-exclusive example of a form of resolution. The shareholder vote must relate to all executive compensation disclosure set forth pursuant to Item 402 of Regulation S-K, with the exception of disclosure provided pursuant to paragraph (s) of Item 402 of Regulation S-K and director compensation required by paragraph (k) or (r) of Item 402 of Regulation S-K;
- Rule 14a-21(b) requires that issuers provide a separate shareholder advisory vote in proxy statements for annual meetings to determine whether the vote on the compensation of executives required by Section 14A(a)(1) of the Exchange Act "will occur every 1, 2, or 3 years." This Say-on-Frequency vote is required not less frequently than once every six years, therefore issuers who first sought a Say-on-Frequency vote immediately after enactment of the Dodd-Frank Act will now have to seek a Say-on-Frequency vote again in the 2017 proxy season;
- Item 24 of Schedule 14A requires disclosure that the issuer is providing the vote pursuant to Section 14A of the Exchange Act, as well as an explanation of the general effect of the Say-on-Pay votes (i.e., the vote is non-binding). Issuers also must disclose, when applicable, the current frequency of Say-on- Pay votes and when the next Say-on-Pay vote will occur;
- Rule 14a-6(a) includes Say-on-Pay and Say-on-Frequency votes in the list of items that do not trigger the filing of a preliminary proxy;
- A Note to Rule 14a-8(i)(10) permits the exclusion of a shareholder proposal that would provide a Say-on-Pay vote, seek future Say-on-Pay votes, or relate to the frequency of Say-on-Pay votes in certain circumstances. Such shareholder proposals could be excluded under the Note if, in the most recent Say-on-Frequency vote, a single frequency received a majority of votes cast and the issuer adopted a policy for the frequency of Say-on-Pay votes that is consistent with that choice. For the purposes of this Note, the SEC states that an abstention would not count as a vote cast;
- An amendment to Item 402(b) of Regulation S-K requires an issuer to address, in the CD&A, whether and, if so, how the issuer has considered the results of the most recent shareholder advisory vote on executive compensation (as required by Exchange Act Section 14A or Exchange Act Rule 14a-20, which is the rule governing Say-on-Pay votes required for recipients of financial assistance under the Troubled Asset Relief Program, or "TARP") in determining compensation policies and decisions and, if so, how that consideration has affected the issuer's compensation decisions and policies. This requirement is included among the "mandatory" CD&A disclosure items specified by Item 402(b)(1) of Regulation S-K; and
- An amendment to Item 5.07 of Form 8-K requires that an issuer must disclose its decision as to how frequently the issuer will conduct Say-on-Pay votes following each Say-on-Frequency vote. In order to comply with this requirement, an issuer must disclose the determination in the original Form 8-K or file an amendment to its original Form 8-K filing (or filings) that disclosed the preliminary and final results of the Say-on-Frequency vote. The Form 8-K amendment is due no later than 150 calendar days after the date of the end of the annual meeting in which the Say-on-Frequency vote occurred, but in no event later than 60 calendar days prior to the deadline for the submission of shareholder proposals as disclosed in the proxy materials for the meeting at which the Say-on-Frequency vote occurred. Specifically with respect to Say-on-Frequency votes, an issuer must disclose the number of votes cast for each of the choices, as well as the number of abstentions in Item 5.07 of Form 8-K.
Rule 14a-21(c) provides that if a solicitation is made by an issuer for a meeting of shareholders at which the shareholders are asked to approve an acquisition, merger, consolidation, or proposed sale or other disposition of all or substantially all of the assets of the issuer, the issuer must provide a separate shareholder vote to approve any agreements or understandings and compensation disclosed pursuant to Item 402(t) of Regulation S-K. Consistent with Exchange Act Section 14A(b), any agreements or understandings between an acquiring company and the named executive officers of the issuer, where the issuer is not the acquiring company, are not required to be subject to the separate shareholder advisory vote.
If any of the agreements or understandings contemplated in Rule 14a-21(c) previously have been subject to a shareholder advisory vote or the Say-on-Pay vote, then a separate shareholder vote is not required at the time of the vote on the merger or other similar extraordinary transaction. If there are changes to the arrangements after the date of the annual meeting or if new arrangements are adopted that were not subject to a prior Say-on-Pay vote, then a Say-on-Golden Parachutes vote is still required. In that case, the vote is required only with respect to the amended golden parachute payment arrangements.
The SEC adopted Item 402(t) of Regulation S-K, which requires disclosure of named executive officers' golden parachute arrangements in a proxy statement for shareholder approval of a merger, sale of a company's assets, or similar transactions. This disclosure is only required in annual meeting proxy statements when an issuer is seeking to rely on the exception from a separate merger proxy shareholder vote by including the proposed Item 402(t) disclosure in the annual meeting proxy statement soliciting a Say-on-Pay vote. The disclosure includes a table labeled "Golden Parachute Compensation," as well as detailed narrative disclosure about the arrangements pursuant to which the compensation is to be paid. The disclosure is also required under a variety of rules and forms; however, the SEC made clear that Item 402(t) disclosure is not required in third-party bidders' tender offer statements, so long as the subject transactions are not also Exchange Act Rule 13e-3 going-private transactions.
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Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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