SEC Proposes Rules on “Say On Pay” for TARP Recipients, Proposes Enhanced Corporate Governance Disclosures and Proxy Solicitation Rule Changes, and Approves Final Rule on Broker Discretionary Voting

July 2, 2009

At an open meeting held on July 1, 2009, the Securities and Exchange Commission ("SEC") approved two sets of rule proposals and one final rule amendment.  These include: 

  • Proposed amendments to the SEC’s proxy rules to implement legislation requiring companies that have received financial assistance under the Troubled Asset Relief Program ("TARP") to hold an advisory shareholder vote on executive compensation (also known as "Say on Pay");
  • Proposed amendments to the SEC’s proxy rules enhancing compensation and corporate governance disclosures and addressing certain rules governing proxy solicitations; and
  • Approval of changes to New York Stock Exchange ("NYSE") Rule 452 that eliminate broker discretionary voting in director elections.

The SEC unanimously approved the two rule proposals and approved the amendments to NYSE Rule 452 by a 3-to-2 vote, with Commissioners Kathleen Casey and Troy Paredes dissenting. 

This summary is based on information provided at the SEC’s open meeting and therefore may not reflect nuances that appear in the official text of the proposals.  The rule proposals will be subject to a 60-day comment period following publication in the Federal Register.  It appears that the SEC wishes to be in a position to adopt final rules that would apply to the 2010 proxy season.

Say on Pay for TARP Recipients

Section 111(e) of the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009 ("EESA"), sets forth certain requirements for companies receiving financial assistance under TARP, including a requirement to allow shareholders an annual advisory vote on certain executive compensation matters.  EESA directed the SEC to adopt final rules and regulations regarding this advisory vote requirement.  Accordingly, the SEC has proposed the following changes to the proxy rules: 

  • New Rule 14a-20, which would require companies that are TARP recipients to provide shareholders with an advisory vote on the compensation of executives (as disclosed pursuant to Item 402 of Regulation S-K) during the period in which financial assistance under TARP remains outstanding.  The proposed rule would make clear that the advisory vote is required only in connection with an annual meeting of shareholders (or a special meeting in lieu thereof) at which directors are to be elected.  This language mirrors the language in EESA.
  • An amendment to Item 20 of Schedule 14A to require TARP recipients to disclose in their proxy statements that they are providing the advisory vote pursuant to EESA and to describe briefly the general effect of the vote, including whether the vote is non-binding.

The SEC staff (the "Staff") made clear that, in order to give companies flexibility to decide how to comply with EESA, the SEC is not proposing specific detailed disclosure requirements regarding the advisory vote.  The SEC clarified that the new rules regarding the advisory vote on compensation do not make substantive changes to the SEC’s executive compensation disclosure rules.  In addition, the Staff clarified that the amendments would not require smaller reporting companies to include a Compensation Discussion and Analysis in their proxy statements in order to comply with proposed Rule 14a-20.  Surprisingly, the SEC did not propose adding these proposals to the list of items that do not trigger a preliminary proxy filing, although it is seeking comment on that issue. 

Amendments to Enhance Corporate Governance Disclosures

The SEC proposed several rule changes to improve disclosures about compensation and corporate governance matters.  Chairman Schapiro emphasized that the rule changes seek to obtain better and more timely disclosure, rather than the disclosure of more information, and to ensure that investors are provided with the "right information."

Specifically, the proposed changes would:

  • Amend Item 401 of Regulation S-K to require that companies provide disclosure about (1) the experience, qualifications, attributes and skills of directors and director nominees that qualify them to serve as a director and as a member of each committee on which they serve, (2) all public company directorships held by directors and director nominees during the past five years, as opposed to just current directorships (as required under the current rules), and (3) the involvement of directors, director nominees and executive officers in legal proceedings during the prior ten years, as opposed to five years (as required under the current rules). 
  • Amend Item 402 of Regulation S-K to require companies to discuss and analyze in the Compensation Discussion and Analysis their overall compensation policies and practices for employees generally, including non-executive officers, if the risks arising from the incentives created by these policies and practices could have a material effect on the company as a whole.  The situations that would require disclosure would vary depending on the company.  The Staff indicated that the SEC believes that this disclosure already is required under the current rules with respect to compensation policies and practices for the named executive officers.
  • Amend Item 402 of Regulation S-K to require companies to report stock and option awards in the Summary Compensation Table and Director Compensation Table using their aggregate grant date fair value as determined in accordance with FAS 123R rather than reporting the dollar amount recognized as an expense for financial statement reporting purposes for the fiscal year. 
  • Amend Item 407 of Regulation S-K to require disclosure about a company’s board leadership structure and why the structure is appropriate for the company.  The proposed disclosure would need to include a discussion of whether the company separates or combines the roles of the chairman and chief executive officer, whether the company has a lead independent director, the board’s role in the company’s risk-management process and the effects, if any, that this role has on the company’s board leadership structure.
  • Require enhanced disclosure of potential conflicts of interests involving compensation consultants that provide advice to the board or compensation committee regarding executive or director compensation and also provide other services to the company.  Specifically, this disclosure would need to include a discussion of (1) any other services that the compensation consultant or its affiliates provide to the company and the fees paid for such services, (2) the aggregate fees paid for advising on executive and director compensation, (3) whether the consultant was engaged for these other services by or on the recommendation of management, and (4) whether the board or compensation committee approved these other services.
  • Require more timely disclosure of annual meeting results by adding a new item to Form 8-K that would require companies to disclose voting results from shareholder meetings within four business days[1] of the annual or special meeting dates.

The SEC also is soliciting comments on whether the SEC should require disclosures about board diversity, including disclosure of whether diversity is a factor the nominating/governance committee considers in recommending director nominees and additional disclosures about diversity on boards.

Amendments to Proxy Solicitation Rules

In addition to the corporate governance disclosure enhancements described above, the SEC proposed certain amendments to the proxy solicitation rules.  In particular, the proposed amendments would:

  • Allow third parties to send out unmarked copies of management’s proxy card to shareholders while communicating their views on matters without having to independently file their own proxy materials;[2]
  • Clarify that a person may have a "substantial interest" in a matter, precluding reliance on the Rule 14a-2(b)(1) exemption (discussed below), where the person derives any benefit beyond security ownership in the company;
  • Allow soliciting parties to round out their "short slates" either with management’s nominees or those of other soliciting parties;[3]
  • Require that any conditions imposed by a soliciting party on the proxy authority granted to it be "objectively determinable;" and
  • Mandate that certain information about participants in a solicitation (such as the identity and interests of participants) be available at the commencement of the solicitation.

The most significant of these changes appears to be the proposal to allow third parties to circulate unmarked copies of management’s proxy card while relying on Rule 14a-2(b)(1) – the proxy exemption allowing communications with other security holders so long as the person does not seek, directly or indirectly, proxy authority, is not a nominee for election as director, has not reserved the right to engage in a control transaction or contested election, and does not otherwise have a "substantial interest" in the subject matter of the solicitation.  This change could embolden third parties to engage in more soliciting activities (such as "just vote no" campaigns) without companies or other shareholders having the benefit of any public disclosure of that soliciting activity and, particularly if combined with the significant changes reflected in the SEC’s recent proxy access rule proposals, could have a dramatic impact on future proxy solicitations.

Elimination of Broker Discretionary Voting in Director Elections

The SEC also approved proposed changes to NYSE Rule 452 that will eliminate broker discretionary voting in director elections.  As discussed in more detail in our client alert issued on March 13, 2009, uncontested director elections are considered a routine matter, meaning that brokers holding shares in street name can vote on behalf of their customers in director elections without specific voting instructions from those customers.  The rule changes will make director elections a non-routine matter, and prohibit brokers from voting uninstructed shares in director elections, at all public companies other than registered investment companies.  In addition, the rule changes codify prior NYSE staff interpretations involving investment advisory contracts.  The amendments will apply to shareholder meetings held on or after January 1, 2010.

Commissioners Casey and Paredes dissented from the SEC’s approval of the amendments to Rule 452, stating that, because of the integrated nature of the proxy voting process, any consideration of changes to the rule should be part of a broader evaluation of issues relating to this process, including investor education, shareholder communications, empty voting and over-voting, and the impact of "e-proxy" on retail shareholder voting levels.  However, there was a consensus among the Commissioners on the need for a comprehensive evaluation of the proxy process, and Chairman Schapiro indicated that in the coming months, the SEC will examine the issues and steps to address them, including possible rulemaking and investor education efforts aimed at making sure that retail shareholders understand the significance of voting.

As companies begin to prepare for the 2010 proxy season, they should keep in mind that the change to Rule 452 may make it more difficult to achieve a quorum at annual meetings.  Broker non-votes are counted for purposes of determining whether there is a quorum only if there is at least one routine matter on the proxy card.  Thus, companies should be sure to include a routine matter (e.g., auditor ratification) on their proxy cards.  In addition, companies considering whether to adopt a majority voting standard in uncontested director elections may consider the potential impact of this amendment to Rule 452 when deciding how to proceed.

  [2]   This amendment, if adopted, would run counter to the Second Circuit’s decision in MONY Group, Inc. v. Highfields Capital Management, 368 F.2d 138 (2nd Cir. 2004), where the court found that a dissident shareholder could not send out copies of management’s proxy card to shareholders and simultaneously rely on the Rule 14a-2(b)(1) proxy exemption.

  [3]   Such a rule would codify the no-action relief recently granted in Application of Rule 14a-4(d)(4) to Solicitation for Proposed Minority Slates of Carl Icahn and Eastbourne Capital L.L.C. (March 30, 2009).  See our client alert issued on April 2, 2009 for further discussion of this no-action letter.

Gibson, Dunn & Crutcher LLP

Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or any of the following:

John F. Olson – Washington, D.C. (202-955-8522, [email protected])
Brian J. Lane – Washington, D.C. (202-887-3646, [email protected]
Ronald O. Mueller
– Washington, D.C. (202-955-8671, [email protected]
Amy L. Goodman 
– Washington, D.C. (202-955-8653, [email protected])
James J. Moloney – Orange County (949-451-4343, [email protected])
Sean C. Feller – Los Angeles (213-229-7579, [email protected])
Gillian McPhee
– Washington, D.C. (202-955-8230, [email protected])
Elizabeth Ising
– Washington, D.C. (202-955-8287, [email protected])

© 2009 Gibson, Dunn & Crutcher LLP

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.