Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
Corporate Services Update 07/20/10 Steven P. Emerick, Joseph D. Masterson, John P. Vail, Jennifer Eichholz, Ryan P. Morrison
On July 15, the U.S. Senate passed the House-approved Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), which will soon be signed by President Obama. The Dodd-Frank Act represents a sweeping restructuring of United States financial regulation in response to the financial system's near collapse in late 2008. It consists of 16 distinct sections addressing all areas of financial regulation. Significant elements of the Dodd-Frank Act include:
- Creation of a new independent watchdog agency intended to serve the interests of consumers of financial products and services.
- New regulations designed to reduce the risk that taxpayers will be required to bail out large financial institutions.
- Creation of an overall financial council that will have oversight of the financial system and is intended to identify and address systemic risks posed by large, complex companies and products.
- Increased regulation with respect to over-the-counter derivatives, asset-backed securities, hedge funds and mortgage brokers.
- A requirement that public company shareholders have a nonbinding vote on executive compensation and authorization for the U.S. Securities and Exchange Commission (the "SEC") to adopt rules granting shareholder access to public company proxy statements for shareholder director nominees.
- New regulations for transparency and accountability of credit rating agencies.
- Strengthened ability of regulators to pursue financial fraud, conflicts of interest and manipulation of the financial system.
This update is one in a series of updates that will be prepared by the Quarles & Brady LLP Financial Regulatory Reform Task Force to address certain portions of the Dodd-Frank Act that are of particular interest to our clients. This update focuses on the corporate governance, executive compensation and whistleblower provisions of the Act.
The Act authorizes, but does not require, the SEC to adopt rules permitting shareholders to include director nominees in a company's proxy statement. The SEC has recently proposed amendments to its proxy rules to permit this type of proxy access (see here). However, the SEC's statutory authority under the Act is broader than its latest proposal (e.g., the SEC would not be required to limit access to long-term or material shareholders, or limit nominations to a minority of the full board with no intent to induce a change of control transaction). The SEC has indicated that it intends to adopt proxy access rules in time for the 2011 proxy season.
(Section 971, amending Section 14(a) of the Exchange Act.)
Disclosure of Chairman and CEO Structure
The Act requires the SEC to adopt rules within 180 days requiring an issuer to disclose in its annual proxy statement whether or not the positions of chairman and CEO are held by two persons or one and, in either case, the reasons why. The effect of this requirement appears to be limited, since the SEC has already adopted amendments to its proxy rules to require this type of disclosure.
Say-on-Pay and Golden Parachutes
The Act requires companies to provide shareholders with a nonbinding vote on the compensation of named executive officers at least once every three years. Not less frequently than once every six years, companies will be required to provide shareholders with a vote on whether this say-on-pay vote will occur every one, two or three years.
In any proxy or consent solicitation material relating to shareholder approval of an acquisition, merger, consolidation or sale, or other disposition of all or substantially all the assets of an issuer, the person making the solicitation must disclose any agreements or understandings with any named executive officer of the issuer (or an acquiring issuer) concerning any type of compensation (present, deferred or contingent) relating to the transaction and the aggregate of all the compensation that may be paid to the named executive officer. In addition, the issuer must provide shareholders with a nonbinding vote on such compensation arrangements.
These new provisions are applicable to meetings occurring six months after enactment of the Act.
(Section 951, amending Section 14 of the Exchange Act.)
Compensation Committee Independence
Members. The Act requires the SEC to adopt rules within 360 days directing the national securities exchanges to require that listed company compensation committee members be independent under a definition of independence to be established by the relevant stock exchange. In crafting the definition of independence, the exchanges must consider
(i) the sources of compensation of a director, including any consulting, advisory or other compensatory fees received from the issuer, and (ii) whether the director is affiliated with the issuer or its subsidiaries and affiliates. This requirement will not apply to controlled companies or to foreign private issuers who explain the reason for their noncompliance.
Advisors. Under the Act, a compensation committee must take into account certain independence factors to be established by the SEC prior to selecting any compensation consultants or other advisors. These independence factors must include at least:
- The provision of other services to the issuer by the advisor.
- The amount of fees received from the issuer relative to the consultant's total revenue.
- Any business or personal relationships of the advisor with any members of the compensation committee.
- Any ownership by the advisor of the issuer's stock.
Committee Authority. The compensation committee must be empowered to retain or obtain the advice of a compensation consultant. In addition, the committee must be directly responsible for the appointment, compensation and oversight of any compensation consultants. However, the committee is not required to follow the recommendations of such consultants and advisors, and must continue to exercise its own judgment in fulfilling its duties. Issuers will be required to provide for appropriate funding for payment of the reasonable compensation of consultants and advisors retained by the committee.
Disclosure. In each annual proxy statement filed by an issuer more than one year following enactment of the Act, the issuer must disclose whether a compensation consultant is used, whether there are any conflicts of interest and how any such conflicts are being addressed.
(Section 952, adding new Section 10C to the Exchange Act.)
Pay Versus Performance Disclosure
The Act directs the SEC to adopt rules requiring each issuer to make its proxy statement disclosures of executive compensation clear, and to include information showing the relationship between executive compensation actually paid and the issuer's financial performance, taking into account changes in the value of the shares of stock and dividends of the issuer and any distributions. The disclosure may include a graphic representation of the information required to be disclosed. In addition, the SEC is directed to require companies to disclose the following comparative compensation information in their annual proxy statements:
- The median annual total compensation of all employees, except the CEO.
- The annual total compensation of the CEO.
- The ratio of the median annual total compensation of all employees except the CEO to that of the CEO.
(Section 953 of the Act, amending Section 14 of the Exchange Act.)
The Act directs the SEC to adopt rules requiring the national securities exchanges to require listed companies to adopt and publish policies to recover unearned incentive compensation in the event of a financial restatement. The rules will require that, if a company is required to prepare an accounting restatement due to material noncompliance with any financial reporting requirement under the securities laws, the issuer must recover any incentive-based compensation (including stock options) paid or awarded to current or former executive officers during the prior three years in excess of what would have been paid or awarded under the accounting restatement. This clawback provision is significantly broader than the existing clawback provision in the Sarbanes-Oxley Act of 2002, which covers only one prior year, applies only to CEOs and CFOs, and applies only to restatements arising from misconduct (although not necessarily the misconduct of the affected executive).
(Section 954 of the Act, adding new Section 10D to the Exchange Act.)
Hedging Disclosure for Employees and Directors
The Act directs the SEC to adopt rules requiring an issuer to disclose in its annual proxy statement whether its employees or directors may purchase financial instruments that are designed to hedge or offset decreases in the value of the issuer's equity securities, including prepaid variable forward contracts, equity swaps, collars and exchange funds. The disclosure will be required as to all issuer securities held by employees and directors, whether acquired through a compensatory plan or otherwise.
(Section 955 of the Act.)
Enhanced Compensation Oversight for Financial Institutions
The Act requires federal regulators, no later than nine months after enactment of the Act, to jointly adopt rules to require disclosure of and to prohibit as an unsafe and unsound practice any compensation plan that provides excessive compensation, fees or benefits to an executive officer, employee, director or principal shareholder, or that could lead to a material financial loss to the bank holding company or other covered financial institution.
(Section 956 of the Act.)
Voting by Brokers
The Act further limits discretionary voting by brokers. Specifically, the Act prohibits a broker that is not the beneficial owner of an issuer's shares from voting the shares with respect to the election of directors, executive compensation or other significant matters (as determined by the SEC by rule) unless the beneficial owner has provided the broker with voting instructions. The Act expands and codifies the recent change to NYSE Rule 452, which provides that brokerage firms cannot exercise discretionary voting and must receive voting instructions from beneficial holders in order to vote on specified "non-routine" matters, including director elections.
(Section 957 of the Act, amending Section 6(b) of the Exchange Act.)
Whistleblower Rewards and Protection
The Act requires the SEC to compensate certain types of whistleblowers who provide original information about violations of the securities laws. In particular, the SEC must pay eligible whistleblowers 10 to 30 percent of the amount of any sanctions, including disgorgement, collected in any covered proceeding in which the SEC levies sanctions of at least $1 million. This is an expansion of the SEC's current permissive authority under the Exchange Act, which caps such compensation at 10 percent of collected penalties and restricts it to the insider trading context. The Act also provides whistleblowers with a private right of action against employers who retaliate against them and a right to appeal a determination regarding an award. Certain types of persons are ineligible for awards, including persons who work for certain regulatory or law enforcement entities, persons who obtain information in the course of a financial audit required by the securities laws and persons who are convicted of a criminal violation related to the action for which the information was provided.
The Act requires the SEC to enact implementing regulations within 270 days.
(Section 922 of the Act.)
For more details on the Dodd-Frank Act, or if you have any questions, please contact one of the Quarles & Brady LLP attorneys listed below.
Steven P. Emerick
John P. Vail
Joseph D. Masterson
(414) 277 5169
Ryan P. Morrison
(414) 277 5401