What to Expect from Dodd-Frank in the 2011 Proxy Season

The new requirements of the Dodd-Frank Act and current trends in shareholder activism are likely to combine to make the 2011 proxy season unlike any before in terms of the range of matters on which boards will need to elicit shareholder support and the level of shareholder engagement:

• Proxy Access: We expect the SEC to act promptly to give substantial shareholders or shareholder groups the ability to include their nominees for a limited number of board seats in the company’s proxy materials. Interest in access is evidenced by the efforts of some institutional shareholders to create databases of potential director candidates. For calendar year companies, we expect the deadline to submit shareholder nominations for inclusion in company proxy materials to be around year-end, subject to the terms of advance notice bylaws (which may need to be reset when the new rules are adopted).
• “Say-on-Pay” Votes: Subject to exceptions the SEC may create, companies will be required to seek a non-binding shareholder vote on the compensation package of their named executive officers at their first meeting held on or after January 22, 2011. This first year, and at least once every six years thereafter, companies will also be required to seek a vote on whether such “say-on-pay” votes should occur every one, two or three years. Note that, in the 2010 proxy season, of 125 management proposals by TARP recipients and other companies seeking an advisory vote on executive compensation, 122 received majority support, with approval averaging more than 74% of the votes cast. [1]
  • Expect continued and perhaps even greater shareholder scrutiny of compensation committee decisions and independence, committee adviser independence, and the pay-performance link (especially for CEOs), all of which will be highlighted by the Dodd- Frank Act’s new disclosure requirements and could influence say-on-pay votes.
• No Broker Discretionary Voting: We expect the SEC and stock exchanges to act promptly so that, in addition to the existing bar on broker discretionary voting for the election of directors, brokers will not be able to vote customer shares without customer instructions on say-on-pay proposals (and perhaps other matters the SEC deems “significant”). We expect this bar to be followed by most if not all bank custodians as well, absent contractual arrangements to the contrary.
• Shareholder Proposals on Governance: Expect access and say-on-pay votes to play out in the context of continuing shareholder proposals on governance issues. In the 2010 proxy season, 35 proposals to separate the positions of Chairman and CEO received an average of 28% support; [2] 31 proposals requiring majority voting in uncontested director elections received an average of 57% support, with 19 receiving a majority of votes in favor; 43 board declassification proposals received an average of 62% support, with 29 receiving a majority of votes in favor; and 43 proposals seeking to establish a shareholder right to call a special meeting received an average of 43% support, with 12 receiving a majority of votes in favor. [3] Also expect an increase in shareholder proposals relating to CEO succession and risk management now that the SEC staff’s liberalized position on inclusion will be available for a full season. [4]

How to Begin to Prepare

We recommend that chief legal officers, corporate secretaries and others in management work with their boards on these and other more specific steps discussed in the complete Briefing (available here):

• Educate Directors and Senior Management: Ensure that senior management and the board are up to speed on the new requirements and understand the heightened pressures. Work with the board to revise its calendar to ensure that the board and its committees have sufficient time to tackle the new requirements.
• Help Shape the Rulemaking Needed to Implement the Dodd-Frank Act: Review SEC and stock exchange rule proposals as published for comment, and consider whether to comment on them, either individually or through industry groups or coalitions.
• Focus on Shareholder Relations: In the period leading up to proxy access and, for most companies, first time say-on-pay votes, reassess the company’s approach to shareholder relations. (For suggested questions to ask, see Appendix B.)
  • Ensure that information systems and communications programs enable management and the board to identify and respond readily to shareholder concerns. Know who your large owners are — the top twenty or thirty shareholders — and consider whether to reach out to them in advance of the next meeting to find out what their concerns are, especially with regard to board composition and executive compensation.
  • Ensure that investor relations personnel are well-versed on institutional investor and proxy advisor positions on “hot button” issues — as well as the company’s rationale where its approach departs from these positions.
  • Ensure that the company’s investor communications policy is up-to-date and well understood by directors and senior management as well as investor relations personnel. [5]
  • Consider extra efforts to encourage retail shareholders to vote.
• Review Compensation Committee Membership and Advisers: To determine whether any changes are likely to be needed to pass forthcoming independence tests, assess the independence of the board’s current compensation committee members applying the independence tests for audit committee members and for advisors apply the general conflict-of- interest disclosure criteria prescribed by the Act for compensation consultants.
• Review Compensation Program and Disclosures: Evaluate the company’s executive compensation program and disclosures from a shareholder perspective, recognizing that they will be put to the test in say-on-pay votes. Focus once again on whether there are any compensation elements that may lead to inappropriate risk-taking. Focus on what the new “pay vs. performance” disclosure will reveal. Management and the compensation committee should take a fresh look at this year’s CD&A to ensure it explains in a clear and convincing way what the company’s compensation philosophy is, how (and how independently) its compensation processes are conducted and the “why” of specific compensation decisions.
  • Consider whether to recommend to shareholders a say-on-pay vote every one, two or three years.
• Recalibrate Disclosure Controls and Procedures: Review and adjust disclosure controls and procedures to capture the additional information that is required to be disclosed.

Endnotes:

[1] Management-sponsored say-on-pay proposals failed at Motorola (receiving the support of 38% of votes cast), Occidental Petroleum (39%) and KeyCorp (45%).
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[2] The highest number of favorable votes this year were 68% of votes cast at Ameron International and 48% votes in favor at Honeywell International.
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[3] Data sourced from RiskMetrics Group’s Governance Analytics service.
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[4] SEC, CF Staff Legal Bulletin No. 14E, Shareholder Proposals (October 27, 2009), available at http://www.sec.gov/interps/legal/cfslb14e.htm. Several shareholder proposals relating to succession were voted on in 2010, with relatively high levels of support at Bank of America (40.1%) and Verizon Communications (32.4%), and lower support at Comcast (14.5%). A shareholder proposal seeking a report on board oversight of risk management at ConocoPhillips received 5% support in 2010.
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[5] Note that the SEC staff recently clarified that Regulation FD does not prevent directors from speaking privately with a shareholder or groups of shareholders, although it urges companies to consider implementing policies and procedures to help avoid Regulation FD violations, such as pre-clearing discussion topics with the shareholder or having company counsel participate in the meeting. SEC, Compliance and Disclosure Interpretations, Regulation FD, Question 101.11 (last updated June 4, 2010), available at http://www.sec.gov/divisions/corpfin/guidance/regfd-interp.htm.
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