Executive Compensation Under Dodd-Frank: an Update

Joseph Bachelder is special counsel in the Tax, Employee Benefits & Private Clients practice group at McCarter & English, LLP. This post is based on an article by Mr. Bachelder, with assistance from Andy Tsang, which first appeared in the New York Law Journal.

The Dodd-Frank law took effect July 21, 2010. [1] Subtitle E of Title IX of Dodd-Frank addresses “Accountability and Executive Compensation” (§§951-957). Since the enactment of the act, the Securities and Exchange Commission (SEC) has adopted final rules as to two of the provisions, proposed rules as to two others and has not yet proposed (but has announced it will be proposing) rules as to another three provisions. This post summarizes the current status of regulation projects under Dodd-Frank Sections 951 through 957.

Final Rules Adopted. The SEC has adopted final rules relating to “Shareholder Vote on Executive Compensation Disclosures” (including the so-called “say-on-pay” vote) (§951) and “Compensation Committee Independence” (§952) (and has approved listing rules relating to compensation committee independence adopted by the New York Stock Exchange (NYSE) and NASDAQ as noted below).

Proposed Rules. The SEC has proposed but not yet adopted final rules with regard to the disclosure of the CEO pay ratio (§953(b)) and, together with several other agencies, enhanced compensation reporting by covered financial institutions (§956).

Rules Not Yet Proposed. The SEC has not yet proposed rules with regard to the following provisions: “Disclosure of Pay Versus Performance” (§953(a)), “Recovery of Erroneously Awarded Compensation” (§954) and “Disclosure Regarding Employee and Director Hedging” (§955).

Finally, as noted below, the NYSE and NASDAQ have adopted (and the SEC has approved) listing rules relating to “Voting by Brokers” (§957).

At the end of the discussion of each Dodd-Frank section, below, there is a “status of rulemaking” summary. This reflects the regulatory agenda (including the SEC’s agenda) contained in the Fall 2013 edition of the semiannual Unified Agenda of Regulatory and Deregulatory Actions published by the Regulatory Information Service Center (available at www.reginfo.gov).

Shareholder Vote (Section 951)

Section 951, which adds Section 14A to the Securities Exchange Act of 1934 (the Exchange Act), requires a non-binding vote on executive compensation as disclosed in the proxy statement (the so-called “say-on-pay” vote) to be provided to shareholders of public companies other than foreign private issuers (as defined in Rule 3b-4(c) under the Exchange Act). [2] (Executive compensation for this purpose means compensation of the named executive officers whose compensation is disclosed pursuant to Item 402 of Regulation S-K.) These companies are required to hold a say-on-pay vote at least once every three years and to schedule a vote on that frequency at least once every six years (the so-called “say-on-frequency” vote).

In addition, the section requires a non-binding vote on golden parachute payments in connection with “an acquisition, merger, consolidation, sale or other disposition of all or substantially all the assets of an issuer” (the so-called “say-on-parachutes” vote).

Current Status of Rulemaking. The final rules under Section 951 were adopted Jan. 25, 2011, and took effect April 4, 2011. Companies to which say-on-pay and say-on-frequency rules apply were required to be in compliance starting with their first annual meeting occurring on or after Jan. 21, 2011. Exception is made for “smaller reporting companies” (generally, those with a public float of less than $75 million), who were required to be in compliance starting with their first annual meeting occurring on or after Jan. 21, 2013. However, all public companies (including smaller reporting companies) are required to comply with the say-on-parachutes rules in applicable filings made on or after April 25, 2011 (but with exceptions for foreign private issuers and emerging growth companies already noted in connection with say-on-pay and say-on-frequency requirements).

Compensation Committee (Section 952)

Section 952, which adds Section 10C to the Exchange Act, covers (a) independence of compensation committees of boards of directors, (b) independence of compensation consultants and other advisers to compensation committees, (c) compensation committee authority with respect to compensation consultants, (d) authority of compensation committees to engage other advisers including their own legal counsel and (e) authority of compensation committees to provide for funding by the issuer of appropriate compensation for such consultants and other advisers. These rules have been the subject of final rulemaking by the SEC and listing rules adopted by the NYSE and NASDAQ (as noted below).

Current Status of Rulemaking. Final rules regarding clauses (a) through (e) above were adopted by the SEC June 20, 2012, and took effect July 27, 2012. (These rules exempt a number of different categories of issuers.) [3] As directed by these rules, the NYSE and NASDAQ adopted their own listing rules, which were approved by the SEC Jan. 11, 2013. The SEC also adopted a new rule under Item 407 of Regulation S-K requiring all public companies (except foreign private issuers) to disclose in a new Item 407(e)(3)(iv) any conflicts the issuer sees in its retention of a particular compensation consultant and how any such conflict is being addressed. [4]

Disclosures (Section 953)

Disclosure of Pay Versus Performance (Section 953(a))

This section, which adds Section 14(i) to the Exchange Act, requires disclosure that involves a rather complex subject: “the relationship between executive compensation actually paid and the financial performance of the issuer, taking into account any change in the value of the shares of stock and dividends of the issuer and any distributions.” As part of this requirement, Section 953(a) refers to Section 229.402 of Title 17 of the Code of Federal Regulations (that is, Item 402 of Regulation S-K, noted above). Presumably, therefore, its reference to “executive compensation” means the compensation of named executive officers as reported in Item 402.

One obvious problem is matching long-term incentive awards with the appropriate periods of financial performance. As part of the problem, long-term incentive awards typically contain variable elements such as vesting, performance targets and timing of payouts once earned. What does the statute mean when it refers to “executive compensation actually paid”? Another problem is determining the financial performance of the issuer. Presumably, in its proposed regulations, the SEC will indicate what criteria in addition to total shareholder return are acceptable for purposes of “measuring” executive compensation against corporate performance.

Current Status of Rulemaking. The SEC’s current rulemaking schedule indicates regulations will be proposed by the end of October 2014.

Disclosure of the CEO Pay Ratio (Section 953(b))

The CEO pay ratio, as provided in the proposed regulations, is the ratio of “the annual total compensation” of the chief executive officer (referred to in regulations as the PEO (principal executive officer) to the median “annual total compensation” of all employees except the chief executive officer. [5] The ratio in the form provided in the proposed regulations is the opposite of the ratio set out in the statute (which is the ratio of the median total compensation of all employees other than the chief executive officer to the total compensation of the chief executive officer).

Current Status of Rulemaking. The regulations were proposed by the SEC on Sept. 18, 2013. Based on the proposal, if final rules were adopted in 2014, the first proxy season to which the new CEO pay ratio rule would apply would be the 2016 proxy season. The proposed rules exempt smaller reporting companies, foreign private issuers and emerging growth companies from the requirements. The SEC’s current rulemaking schedule indicates that final rules will be adopted by the end of October 2014.

Recovery of Erroneously Awarded Compensation (Section 954)

Section 954, which adds Section 10D to the Exchange Act, requires that current or former “executive officers” [6] repay to the issuer (a “clawback”) any “incentive-based compensation (including stock options awarded as compensation)” received “during the 3-year period preceding the date on which the issuer is required to prepare an accounting restatement, based on the erroneous data, in excess of what would have been paid to the executive officer under the accounting restatement.” [7]

Current Status of Rulemaking. The SEC’s current rulemaking schedule indicates regulations will be proposed by the end of October 2014.

Disclosure Regarding Employee and Director Hedging (Section 955)

Section 955, which adds Section 14(j) to the Exchange Act, requires the issuer to disclose whether any of its employees or directors (or any designee of such employee or director) is permitted to hedge equity securities of the issuer that are granted to such employee or director as part of compensation arrangements or that are otherwise held by such employee or director.

Current Status of Rulemaking. The SEC’s current rulemaking schedule indicates regulations will be proposed by the end of October 2014.

Financial Institutions (Section 956)

Section 956 requires covered financial institutions to make disclosures under regulations issued by the SEC and other regulatory agencies that will enable shareholders to determine whether compensation to executive officers and other persons employed or affiliated with the covered financial institution constitutes excessive compensation or compensation that could lead to “material financial loss to the covered financial institution.” Section 956(b) prohibits certain types of compensation arrangements that encourage “inappropriate risks by covered financial institutions.” Covered financial institutions with assets of less than $1 billion are exempted from these requirements.

Current Status of Rulemaking. Seven federal regulators, including the SEC, are required to jointly prescribe rules under Section 956. [8] On March 29, 2011, the SEC issued proposed rules made jointly with six other agencies (who had previously issued their proposals which were consistent with the SEC release). [9] If adopted, they would become effective six months after final rules are published in the Federal Register. The SEC has not indicated when final rules will be published.

Voting by Brokers (Section 957)

Section 957, which amends Section 6(b) of the Exchange Act, requires national securities exchanges to prohibit brokers from voting on behalf of the beneficial owners of stock, except as directed by those beneficial owners, with respect to votes on the election of a member of the board of directors (excluding an uncontested election), executive compensation or any “other significant matter” as determined by the SEC.

Current Status of Rulemaking. The SEC has approved the listing rules issued by the NYSE (approval was given on Sept. 9, 2010) and by NASDAQ (approval was given on Sept. 24, 2010). It has not issued a rule as to the meaning of “other significant matter.”


[1] Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Pub. L. No. 111-203, 124 Stat. 1376 (2010).
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[2] Separately, the Jumpstart Our Business Startups Act (Pub. L. No. 112-106, 126 Stat. 306 (2012)) (JOBS Act), enacted on April 5, 2012, exempts “emerging growth companies” (as defined in the JOBS Act) from the requirements of Section 951 as well as Section 953. The JOBS Act also provides to “emerging growth companies” less burdensome compensation-related disclosure requirements under Item 402 of Regulation S-K (which provides similar treatment to smaller reporting companies). An “emerging growth company,” as defined in Section 101 of the JOBS Act, must have annual gross revenues of less than $1 billion (adjusted at five-year intervals by the SEC for inflation) during its most recently completed fiscal year and meet certain other criteria set out in Sections 101(a) and (b) of the JOBS Act. (Sections 101(a) and (b) amend both the Securities Act of 1933 and the Exchange Act. An issuer will not qualify as an “emerging growth company” if it had an IPO of common equity on or before Dec. 8, 2011 (Section 101(d) of the JOBS Act).
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[3] New Exchange Act Section 10C(a)(1) exempts five specified categories of issuers from listing rules regarding compensation committee independence as required by Section 10C(a)(1). These five categories are controlled companies (as defined in Section 10C(g)(2)), limited partnerships, companies in bankruptcy proceedings, open-end management investment companies registered under the Investment Company Act of 1940 and foreign private issuers that provide annual disclosures to shareholders of the reasons why the foreign private issuer does not have an independent compensation committee. In addition, the SEC (in Rule 10C-1(b)(5) under the Exchange Act) exempts from the requirements of Section 10C altogether any “controlled company” (as defined in Rule 10C-1(c)(3) under the Exchange Act) and any “smaller reporting company.” (“Smaller reporting company,” as noted in the text at Paragraph 1, generally means a company with a public float of less than $75 million).
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[4] It is important to note that the requirements of new Exchange Act Section 10C(b) through (e) relating to compensation consultants and other advisors to compensation committees apply to issuers; they are not limited to listed companies. In promulgating Rule 10C-1 the SEC was acting in accordance with Exchange Act Section 10C(f). That section requires that within 360 days of Dodd-Frank’s enactment the SEC adopt rules applicable to the listing requirements of securities exchanges. Based on the language of the statute (not SEC Rule 10C-1), issuers that are unlisted public companies are subject to the rules of Exchange Act Section 10C, at least those of subsections (b) through (e). This appears to be so whether or not the SEC promulgates any further rules directly applicable to those companies.
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[5] Under the proposed regulations, “all employees” include all individuals “employed by the registrant or any of its subsidiaries as of the last day of the registrant’s last completed fiscal year. This includes any full-time, part-time, seasonal or temporary worker employed by the registrant or any of its subsidiaries on that day (including officers other than the PEO).” The proposed regulations also provide that “[a] registrant may annualize the total compensation for all permanent employees (other than those in temporary or seasonal positions)….” The preamble to the proposed regulations states that “all employees” include non-U.S. as well as U.S. employees and that reduction for cost-of-living adjustments for non-U.S. employees is not permitted. The proposed regulations provide that a “statistical sampling or other reasonable methods” may be used instead of the entire employee population. Also, it is noted that the median employee may be calculated using an acceptable alternative to “annual total compensation.” (For this purpose, “median employee” refers to the employee whose total compensation is at the median for total compensation of all employees in the applicable employee population.) For example, a registrant may use “any other compensation measure that is consistently applied to all employees included in the calculation, such as amounts derived from the registrant’s payroll or tax records.” Once the median employee is identified, the compensation of such person (for purposes of the pay ratio) is calculated based on the same categories of compensation that make up total compensation for purposes of the summary compensation table (as required under Item 402 of Regulation S-K in reporting total compensation of named executive officers).
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[6] Presumably “executive officer” for purposes of Dodd-Frank Section 954 has the meaning given that term by Rule 3b-7 under the Exchange Act.
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[7] For other federal statutes with their own “clawback” provisions, see Sarbanes-Oxley Act of 2002, Section 304 and the Emergency Economic Stabilization Act of 2008, Section 111(b)(3)(B), as added by Section 7001 of the American Recovery and Reinvestment Act of 2009.
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[8] The other six federal regulators are the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency (OCC), the Board of Directors of the Federal Deposit Insurance Corporation (FDIC), the director of the Office of Thrift Supervision (OTS), the National Credit Union Administration Board (NCUA) and the Federal Housing Finance Agency (FHFA).
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[9] The SEC, and the other six agencies, have not limited their rulemaking under Dodd-Frank Section 956 to the description of risk-taking circumstances that would constitute failure to meet the requirements of Section 956(b). The rulemaking goes beyond that and establishes performance requirements that must be met by certain financial institutions in order to avoid being out of compliance with Section 956(b). For example, the proposed rules require a three-year minimum deferral period for at least 50 percent of the annual “incentive-based compensation” for “executive officers” at certain financial institutions. See, for example, Section 248.205(b)(3)(i) of the rule as proposed by the SEC. (The two quoted terms, “incentive-based compensation” and “executive officers,” are defined in each of the agencies’ versions of the proposed joint rule.).
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