The Financial Reform Bill’s Implications for the 2011 Proxy Season

We’re not yet through 2010 and we’re already writing about 2011?  Well, given the Senate’s passage of the Financial Reform Act we are now much closer to a new reality of major governance changes being imposed on companies of all sizes by regulation.  This proxy season, we have all been operating in the shadow of these potential wide-ranging corporate governance reforms. Even as companies and governance advocates have gone about business-as-usual, our anticipation of change – and the desire to see a settled landscape – has been enormous. It has been difficult to go more than a few days with no headlines from The Wall Street Journal or Financial Times, or our alerts or those from other industry players, keeping you aware of the latest twists and turns on the status of governance-related legislation.

In this article, we provide you with our perspective on the pending changes and their prospective impact for the remainder of 2010 and the 2011 proxy season.  Our analysis will attempt to take into account the fast changing legislative environment in Washington, D.C. Of the eight corporate governance-related items that need to be integrated by a House/Senate conference committee, only two at present appear to be close enough that observers (and political insiders) view them as relatively done deals: Say on Pay and Proxy Access.  Of the other changes being considered, majority voting for directors in uncontested elections would, if in the final bill, clearly have the most impact.

Say on Pay (SOP)

Presently, any discussion of SOP needs to qualify whether the proposal is management’s, seeking approval of executive compensation from stock owners, or a shareholder resolution seeking the board’s adoption of the advisory vote on executive pay.  Once the final bill passes, the advisory vote on compensation will be an annual fixture in the proxy statement.

Voluntary adopters and mandatory proposals

To date, there have been 637 Say on Pay proposals brought forth by management, which is almost a 20% increase from 2009 when there were 518 as of this time last year.  These figures include firms that participated in the TARP program and were required to place SOP management proposals in the proxy and a number of companies who chose, in response to resolutions from activist institutional investors, to adopt SOP for submission to stock owners.

The majority of firms submitting SOP proposals to their shareholders this year have, thus far, experienced high ratification votes with overwhelming support in the high 90 percentiles. A serious caveat that boards and senior managers need to keep in mind is that the SOP proposal is presently a routine item under NYSE rules, allowing brokers to vote uninstructed client’s shares in favor of the SOP resolutions.  A provision in the bill approved by the Senate would make SOP proposals a non-routine item and as is now the case with director elections – brokers would not be able to vote clients’ shares for management SOP proposals.

As we see it, under a mandatory SOP regime – without the safety net provided by the broker vote – companies will have a much more difficult time getting a high percentage approval vote from shareholders for executive compensation advisory votes.  According to impact analyses we conducted on the effects of NYSE Rule 452 on companies with a significant retail shareholder base (20% to 60%), they could expect a drop off in the range of 10% to 44% in voting for directors.  Putting this into the Say on Pay context, issuers should expect to see a similar and sizable decrease in the percentage of support for these management proposals in 2011.  Issuers would be strongly advised to also consider the results of the KeyCorp, Motorola and Occidental SOP votes (which failed to achieve majority support) when thinking about the exclusion of broker votes effect upon SOP proposals going forward.

Proxy Access

Both the House and Senate versions support or require the SEC to adopt some form of proxy access, and it will be up to the SEC to decide on the shape, scope and reach of proxy access.  The Senate and House bills (see Senate language below) provide an open and broad framework for proxy access, leaving the details to the SEC to fill in as the agency deems appropriate. The SEC has provided little indication of the criteria to be established for investors to utilize proxy access.

Restoring American Financial Stability of 2010

SEC. 972. PROXY ACCESS.
(a) Proxy Access- Section 14(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78n(a)) is amended–
(1) by inserting “(1)” after “(a)”; and
(2) by adding at the end the following:
“(2) The rules and regulations prescribed by the Commission under paragraph (1) may include –
“(A) a requirement that a solicitation of proxy, consent, or authorization by (or on behalf of) an issuer include a nominee submitted by a shareholder to serve on the board of directors of the issuer; and
“(B) a requirement that an issuer follow a certain procedure in relation to a solicitation described in subparagraph (A)”.
(b) Regulations- The Commission may issue rules permitting the use by shareholders of proxy solicitation materials supplied by an issuer of securities for the purpose of nominating individuals to membership on the board of directors of the issuer, under such terms and conditions as the Commission determines are in the interests of shareholders and for the protection of investors.

What is clear at this point is that proxy access (in some form) and Say on Pay will become increasingly important considerations, if not preoccupations, for boards of directors and executive management teams going forward.

Unresolved Issues Between the House and Senate Bills

There are a number of unresolved issues between the House and Senate bills that require reconciliation before a final vote can be taken by both houses of Congress, and the bill (once passed) can be presented to President Obama.  As the status of these issues becomes clearer, we will endeavor to give you a sense of the impact on issuers and the reaction of the wider corporate governance community.

Majority Vote for Director Elections – A Maybe?

Comments made on Tuesday of this week by Congressman Barney Frank, Chairman of the House Financial Services Committee (D-MA), and reported on the RiskMetrics blog by Ted Allen seemed to indicate that language in the Senate bill calling for a mandatory majority vote/resignation regime may not survive the conference committee process.  As of our publication date, no other public comments have been made about the fate of the remaining issues.

We reached out to a number of sources close to the process, on the House and Senate side and within both parties, seeking a consensus on the possibility of reconciliation of the Senate and House provisions.  The essential take:  bigger issues in the bill such as the fate of Senator Lincoln’s amendment to restrict derivatives trading by banks will drive the process and overshadow many of the outstanding corporate governance issues.  Late Tuesday afternoon, WSJ.com reported that Senate conference committee members had been named.  Given the impeding Memorial Day weekend, it is not clear if the House will have all of its committee members selected until sometime next week, at the earliest.

We will endeavor to keep you informed on the status of the reconciliation process as we become aware of changes.