With the Dodd-Frank Wall Street Reform and Consumer Protection Act (“the Act”) signed into law by President Obama on 21 July 2010, the US has finally introduced a non-binding shareholder vote on executive pay.  But, more importantly from a governance perspective, the US backpedalled on the introduction of majority voting for electing directors.  While Australia and the UK have majority voting, in the US most companies use plurality voting, under which the candidate with the most votes is elected even if they do not have a majority (executive chairmen often control nominations and, if there is only one candidate, one vote is enough to be elected).  It is likely that the low level of shareholder influence over the election of directors in the US has contributed to the ‘capture’ of boards by executive chairmen and, in turn, to executive pay that far exceeds the rest of the world.  This is unlikely to change.  As a result, the US will continue to a primary influence on global executive pay increases as the rest of world plays catch up.

However, the US legislation includes some measures that could be picked up by other countries, including Australia, if the Australian Labor Party is successful in the forthcoming election (see the 2010 Australian Labor Party election platform HERE, and contrast their views on executive pay matters with the Coalition parties’ economic principles, include a commitment not to “blindly follow the global push for more regulation” in the financial sector  HERE).

 

We discuss the new US measures below.

Corporate Governance Reforms

Nomination of directors.  The Act affirms that the SEC may promulgate rules permitting the use by a shareholder of company proxy materials to nominate director candidates.  It is expected that the SEC will take final action in this area soon after the Act is signed into law in light of Chairman Schapiro’s recent statements confirming that she expects proxy access to be in effect for the 2011 proxy season.  It is likely that the rules will, in effect, be similar to Australia’s Corporations Act.

 

No majority voting for director elections.  In a compromise with the House version of the financial reform bill, the requirement for all public companies to adopt majority voting has been eliminated from the final version of the Act. 

 

Chairman and CEO disclosures.  The Act amends Section 14B of the Securities Exchange Act of 1934 to direct the SEC to issue rules requiring companies to disclose in their annual proxy statements the reasons why the company has chosen to combine or separate the board chair and CEO positions.  Similar disclosure is required under current SEC rules, so it is unclear whether this provision will result in any additional disclosure requirements.

 

Executive Compensation Reforms

Say-on-pay.  The Act requires a separate non-binding vote of company shareholders (at least every 3 years) to approve the company’s executive compensation.  In addition, at least every six years, shareholders must be provided with a separate non-binding vote on whether the say-on-pay vote will occur every one, two or three years – but the company makes the ultimate decision.

 

Say-on-golden parachutes.  Whenever shareholders are asked to approve a change in control transaction, they must also be given a non-binding vote on approval of any associated ‘golden parachute’ arrangements (unless these have previously been subject to a say-on-pay vote on executive compensation). While US golden parachutes dwarf termination payments in Australia and the UK as a multiple of salary, the tenor of the US law covers an area in relation to which there is a loophole in Australian law.

    

 

Australian terminations payment law (see HERE) does not cover benefits paid on a change in control, because the Listing Rules prohibit any entitlement to termination benefits on a change in control.  So the new owners may terminate an executive, but prior to termination an Australian executive may receive a change in control payment without shareholder approval.

Disclosure of say-on-pay and say-on-golden parachute votes by institutional investors.  The Act requires institutional investment managers to disclose their say-on-pay and say-on-golden parachute voting records at least annually unless otherwise required by the SEC.  The Australian government recently elected not to go down this path, while encouraging institutional investor bodies to review guidelines in this regard.

 

Compensation committees.  Like the pending changes to ASX Listing Rules for ASX 300 companies, the US legislation obliges the SEC to direct the national securities exchanges to require that all members of compensation committees of U.S. listed companies be independent and that compensation committees be given certain oversight responsibilities and adequate funding to carry out those responsibilities.  However, unlike Australian principles-based requirements, the US law is prescriptive in determining independence for this purpose, as the Act requires the securities exchanges to consider certain factors, including the source of compensation for the director (such as any consulting, advisory or other compensatory fees paid by the company) and whether the director is affiliated with the company, a subsidiary of the company or an affiliate of a subsidiary of the company. 

 

Compensation advisers.  The US act has certain pointers that could be considered in the redrafting of Australian law indicated by the government to be in place for the 2011 financial year. 

 

When engaging compensation consultants, legal counsel or other advisers, compensation committees must consider certain independence factors to be determined by the SEC, including (i) what other services the employer of the consultant or adviser provides to the company, (ii) the amount of fees the employer of the consultant or adviser receives from the company as a percentage of revenue for such employer, (iii) the policies and procedures related to conflicts of interest of the employer of the consultant or adviser, (iv) any business or personal relationships between the consultant or adviser and the members of the compensation committee and (v) any stock of the company owned by the consultant or adviser.  However, the Act does not prohibit compensation committees from choosing advisers who are not independent. 

 

The Act further specifies that the engagement of advisers under these new rules will not require compensation committees to act in accordance with the adviser’s recommendations.  Also, in any proxy or consent solicitation for an annual meeting, companies will have to disclose (i) whether the compensation committee used any compensation consultants and (ii) whether any such compensation consultant identified any conflicts of interest and, if so, how the conflict is being addressed by the company.  Finally, the Act requires the SEC to conduct a study of the use of compensation consultants and the effects of such use and to report the results of the study to Congress no later than two years after the Act’s enactment.

 

Several features of the US Act could be considered in the drafting of the rules in this area that the Australian government has indicated will be in place for the 2011 financial year.  In particular, the US provisions apply to all advisers to the compensation committee, including legal counsel, which we believe is something that certain vested interests in Australia are actively lobbying against in the Australian version.  In addition, factors governing independence are prescribed.

 

 

Pay-for-performance disclosure.  The Act amends Section 14 of the Exchange Act to direct the SEC to issue rules requiring that named executive officer compensation disclosures include a “clear description” of the relationship between executive compensation actually paid and a company’s financial performance, taking into account any change in the value of the company’s stock and dividends and other distributions.  This disclosure could include a graphic representation of the required information.

 

It is unclear what additional disclosure would be required as a result of this provision since similar disclosure is already currently required under SEC rules. 

 

Pay-parity disclosures.  US companies are also required to disclose indicators of pay parity.  Specifically (i) the median annual total compensation of all employees, other than the CEO, (ii) the annual total compensation of the CEO and (iii) the ratio of the median total annual employee compensation to that of the CEO. 

 

Of course, one unintended consequence may be more outsourcing of lower level work to India and other lower wage countries.

 

Executive compensation clawbacks.  The Act adds a new Section 10D of the Exchange Act under which the SEC must direct the national securities exchanges to require companies to develop and implement policies for clawback of executive officer compensation in the event a company is required to prepare an accounting restatement due to material non-compliance of the company with financial reporting requirements under securities laws.  Companies that do not comply will be prohibited from listing their securities.  The SEC is also to issue rules requiring companies to disclose what incentive-based compensation is based on financial information required to be reported under the securities laws.  Hence, one unintended consequence may be more reliance on non financial objectives for bonus payments, creating the potential for more divergence between pay and company performance.

 

Clawback will apply to incentive-based compensation (including stock options) paid during the three-year period preceding the restatement, and the recovery would be the amount in excess of what otherwise would have been paid to the officer.  The Act expands the clawback provision contained in the Sarbanes-Oxley Act of 2002, which applies only to compensation received by the CEO and CFO and then only during the 12-month period following the first issuance of the restatement and only if the restatement resulted from misconduct.

 

The US provisions may provide useful pointers for the clawback laws the Australian government has announced it will enact. 

 

Hedging disclosure.  The Act requires companies to disclose in any proxy or consent solicitation material for an annual shareholder meeting whether any employee or director (or designee) is permitted to purchase financial instruments that are designed to hedge or offset any decrease in the market value of equity securities of the company (including prepaid variable forward contracts, equity swaps, collars and exchange funds) that are granted as compensation or otherwise held by the employee or director.

 

Banker pay.  The Act directs the “appropriate federal regulators” of “covered financial institutions” to require each institution to disclose to its regulator the structure of its incentive-based compensation arrangements This disclosure is required so the regulator can determine whether the incentive structure provides the institution’s executive officers, employees, directors or principal shareholders with excessive compensation, fees or benefits or could lead to material financial loss to the institution.  No reporting of the actual compensation of particular individuals would be required. 

 

“Covered financial institutions” includes bank holding companies, registered broker-dealers, insured credit unions, investment advisers and any other financial institution as determined by the appropriate federal regulators, with assets of at least US$1 billion.  “Appropriate federal regulators” include the Federal Reserve, the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, the National Credit Union Administration Board, the SEC and the Federal Housing Finance Agency.

 

Further, the appropriate regulators must jointly issue rules to prohibit any incentive-based payment arrangement that they determine will encourage inappropriate risk-taking by the covered financial institutions by providing their executive officers, employees, directors or principal shareholders with excessive compensation, fees or benefits or that could lead to material financial loss to the institution.

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