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The Dodd-Frank Wall Street Reform and Consumer Protection Act created Section 14A of the Securities Exchange Act of 1934, which requires most public companies to conduct a shareholder advisory vote on executive compensation not less frequently than every three years; and to allow stockholders to vote once every six years on whether the “say-on-pay” vote should occur every one, two or three years. The compensation arrangements subject to vote include those paid to the chief executive officer, the chief financial officer and the three other highest-paid executive officers.

Section 14A specifically provides that these resolutions will not overrule the board’s compensation decisions or create or imply any change to or any additional fiduciary duties for the issuer or board.

Despite disclaimers by Congress, at least 10 companies are now facing one or more derivative lawsuits following negative stockholder votes. These complaints set forth similar allegations, including claims for breach of the fiduciary duty of loyalty against the company’s current directors, claims against the recipients of the pay raises for unjust enrichment, and claims against the company’s compensation consultant for aiding and abetting breaches of fiduciary duty.

Most interesting, the complaints also allege that the “no” vote constitutes “direct and probative evidence” that the pay decisions were not in the best interests of the company’s stockholders. This allegedly overcomes the business judgment rule and shifts the burden to the defendants to prove that the challenged compensation decisions were made in good faith and in the stockholders’ best interests.

It may seem difficult to understand how a nonbinding stockholder vote that, by its terms, was not to overrule the board’s compensation decisions or impose any new or enhanced fiduciary duties, could alone be sufficient to defeat the business judgment rule. One federal court, however, has found the argument persuasive, at least at the motion-to-dismiss stage. In NECA-IBEW Pension Fund v. Cox, Cincinnati Bell shareholders brought suit after the directors, inter alia, granted $4 million in bonuses, plus $4.5 million in salary to the CEO, in the same year that the company incurred a “$61.3 million decline in net income, a drop in earnings per share from $.37 to $.09, [and] a reduction in share price from $3.45 to $2.80.” Sixty-six percent of the voting shareholders voted against the plan. The court recognized that the negative vote was not binding nor should it alter the directors’ fiduciary duties, but nonetheless held that, under Ohio law, the business judgment rule did not apply because the factual allegations raised “a plausible claim that the multimillion dollar bonuses approved by the directors in a time of the company’s declining financial performance violated Cincinnati Bell’s pay-for-performance compensation policy and were not in the best interests of … [the] shareholders and therefore constituted an abuse of discretion and/or bad faith.”

As the business judgment rule “imposes a burden of proof, not a burden of pleading,” it may be that the plaintiffs are ultimately unable to prove the directors acted with “a deliberate intent to cause injury” or “reckless disregard for the best interests of the corporation” at trial, but their allegations were sufficient at the pleading stage.

The Georgia Superior Court reached the opposite conclusion in Teamsters Local 237 Additional Security Benefit Fund v. McCarthy et al. There, the directors of Beazer Homes recommended that the shareholders approve the 2010 compensation plan, which included raises for executives in a year in which the company suffered a $34 million net loss and a 17 percent decline in share price. The shareholders rejected the recommendation.

The complaint alleged, inter alia, that by approving the plan, recommending that the shareholders approve the plan and failing to rescind the plan after the negative vote, the directors breached their fiduciary duties to the company.

The court disagreed, holding under Delaware law that neither the negative vote nor the directors’ decision not to rescind the plan rebutted the business judgment rule. The directors could not have considered the results of the February 2011 vote when they approved and recommended the plan in 2010. As such, the vote failed to cast doubt that the directors acted on an informed basis, in good faith and in the company’s best interests a year earlier. “Hindsight second-guessing and Monday morning quarterbacking of the sort [the stockholders] urge are fundamentally inconsistent with the business judgment analysis,” the Georgia court wrote.

Even prior to this uncertainty, other suits had settled, encouraging more suits. In March 2011, KeyCorp, after being sued under a similar provision found in the Troubled Asset Relief Program (TARP), agreed to make changes to its compensation practices and to pay $1.75 million to the plaintiffs’ law firms. Recently, perhaps as a consequence of the unfavorable decision received in the Ohio federal court, Cincinnati Bell announced that it had reached a settlement in another lawsuit, pending in Ohio state court, involving its compensation plan.

In light of these varying outcomes, companies should recognize that they could be targets of similar litigation and take steps that may reduce the risk of such suits.

Know your constituents. Prior to any vote, consider: Have significant institutional investors previously indicated that they are unhappy with the company’s compensation practices or decisions? Have any of these same institutions voted “no” at other companies or filed suit, and if so, why? Are there aspects of the company’s recent performance that could be characterized (rightly or wrongly) as “disappointing”? Can the company take steps by way of additional communication, disclosure or the like, to address these risk factors proactively and render a positive vote more likely?

Be prepared. If there is genuine risk of a “no” vote, have a plan. Will the compensation committee revisit a rejected decision and adjust it, or will only prospective adjustments be considered? What are the ramifications (accounting and otherwise) of a retroactive adjustment? As a matter of good corporate housekeeping, the minutes of compensation committee and board meetings should capture and accurately convey the rationale for any action or nonaction that is taken in light of a negative vote.

Review your disclosures. Consider explaining what is meant by “pay for performance.” The plaintiffs’ bar often seeks to use the company’s Compensation Discussion & Analysis to support their claims, usually relying upon language that the company has a pay-for-performance policy. This argument is based on the latent ambiguity in terms that may not be defined or described in detail in the CD&A. Companies should consider explaining whether “pay for performance” means that pay is based solely upon total shareholder return, or whether it takes into account other considerations. Disclosing what goes into executive compensation decisions can provide defense counsel with more robust disclosures to rely upon, including in seeking to have claims dismissed at the outset.

Potential Impact on Compensation Advisors
The plaintiffs’ bar is also pursuing “aiding and abetting” claims against compensation advisors. As a result, companies should review whether, and to what extent, they have indemnification obligations, whether such obligations are insured, and what impact a lawsuit might have on their relationship with their advisor.

Roger A. Lane is a partner in law firm Foley & Lardner’s Securities Enforcement & Litigation Practice. He can be reached at rlane@foley.com. Courtney Worcester is senior counsel in the Boston office of Foley & Lardner. Her practice focuses on complex commercial litigation involving corporations, venture capital and private equity firms, financial institutions and their directors and officers. She can be reached at cworcester@foley.com.

Larry Smith (left), Terry Iannoconi and Rosalie Wolf (photos by Jacuqulyn Maisonneuve)

One key area of interest was the need for detailed disclosures of corporate political contributions in light of the Citizens United case, and “robust oversight” of donations. A clear policy on the reporting is necessary for any company, participants said, with some investors calling for a “no-donations” policy at some firms.

Company policies were widely approved by shareholders in 2011, with ISS’s final U.S. Postseason Report noting that proxy contests were less prevalent in the past year. Only nine contested meetings went to a shareholder vote during the first half of 2011, compared to 14 and 25 for the same periods in 2010 and 2009, respectively.

This article is adapted from the “Summary of Proceedings of the 2011 Audit Committee Chair Advisory Council,” available free to all NACD members at NACDonline.org.

“Say-on-pay” proposals were voted down at 1.6 percent of the Russell 3000 firms reporting results, involving only 38 companies through September 2011, and pay programs received an average of 92.1 percent support from investors. As say-on-pay votes gave shareholders an alternative to voting against compensation committee members, the number of Russell 3000 directors failing to garner majority support fell by nearly half.

An SEC update to the Advisory Council highlighted a number of issues upper most on the Commission’s agenda with key implications for audit committee oversight—including Dodd-Frank rulemaking on conflict mineral disclosures, clawbacks of executive compensation and median-pay calculations, as well as offshore cash and the use of non–GAAP metrics in SEC filings.

Advisory Council delegates expressed particular concern over future clawback provisions. They agreed on the importance of ensuring a clear, unambiguous tone at the top and expectations that all relevant facts are considered when making a restatement decision. Yet some noted that the clawback provisions raise some problematic questions, including: Do companies have the systems to implement this? What are the metrics being used? And, if earnings per share (EPS) is used, will it create measurement challenges related to shares outstanding, timing and other inputs to the EPS metric?

In addition, the SEC update noted that the Commission may consider allowing statistical sampling to alleviate possibly cumbersome calculations of median pay, and is examining material disclosures regarding cash held offshore.

Auditors emphasized the need to consider the potential impact of accounting changes on IT systems. In order to avoid “Y2K-like scrambles,” Advisory Council delegates agreed that both audit committees and management should begin identifying what the company needs for implementation, including processes and resources.

Concern about the volume of disclosures required in SEC filings was a particular sticking point. Participants noted the ongoing problem of “disclosure overload,” compounded by the widespread use of boilerplate disclosures driven largely by the fear of litigation. “Telling investors that if the company doesn’t sell products its performance could suffer, doesn’t tell them anything, really,” said one participant.

The Public Company Accounting Oversight Board has a number of initiatives underway, including possible changes to the auditor’s traditional “pass/ fail” reporting model and mandatory audit firm rotation. There was general agreement that a more robust audit committee report—describing in more detail what the audit committee does—would be beneficial. However, the scope of an expanded audit committee report may be limited to what corporate counsel is comfortable saying in the proxy. Attendees also expressed desire for more communication and transparency about the PCAOB inspection process and the significance of inspection findings.

Regarding auditor independence and skepticism, participants noted the difficulty of challenging the auditors. Using executive sessions effectively and meeting with the auditor informally, outside of regular meetings, may be invaluable solutions. While informal meetings may provide additional nuance, in formal meetings the auditor should provide views and perspective, not simply “We did the audit, and it complies with accounting standards.”

Citing the 2011 KPMG Audit Committee Institute survey that revealed that IT risk and emerging technologies are the top issues that audit committee members want to devote more time to over the next 12 months, participants discussed the significant— and accelerating—challenge of effectively overseeing IT risk and governance.

Boards (often with the audit committee taking the lead) are delving deeper into the risks posed by IT and emerging technologies that are transforming the business landscape, from cloud and social media to mobile devices and data analytics. “Defensive” IT risks—data security and privacy, compliance, business continuity and the integrity of financial reporting system—are in the forefront, but boards are also increasingly concerned about strategic IT risks— those posed by the failure to leverage technology to innovate and build competitive advantage. As a leading practice, companies are putting “governance frameworks” into place for IT, data and social media to help manage and oversee these assets as a risk and an opportunity. “Any board that’s not focused on this is missing the boat,” noted one audit chair.

Recognizing that information prepared and presented by management can dominate the boardroom agenda and dialogue, attendees discussed the ongoing challenge of “asymmetric information risk,” as well as clues or indicators of when this risk is too high. While clearly a full board issue, audit committees—given their inclination to view information through a “risk lens”—may be in the best position to monitor this issue.

The group discussed what actions would be meaningful countermeasures to asymmetric information risk, with much of the dialogue focusing on the importance of bringing third-party information and “dissenting views” to the board.

Takeaways
NACD identified three action items stemming from the dialogue to advance audit committee practices and address the common objectives of Advisory Council representatives:

• Identify and facilitate opportunities for audit committee chairs to meet with the PCAOB and exchange views on a more regular and proactive basis.
• Draft a model or template for an expanded audit committee report.
• Develop a board-level educational resource to help directors better understand—and stay apprised of—IT risks and emerging technologies.

Participants
Charles E. (Eddie) Adair: Audit Committee Chair, Tech Data Corp.

James B. Bachmann: Audit Committee Chair, Nationwide Insurance

Joseph R. Bronson: Audit Committee Chair, Jacobs Engineering Group

Meredith B. Cross: Director, SEC Division of Corporation Finance

Gerald M. Czarnecki: Audit Committee Chair, State Farm

Kenneth Daly: President and CEO, National Association of Corporate Directors

Cynthia A. Fornelli: Executive Director, Center for Audit Quality

Peter Gleason: CFO, Managing Director, National Association of Corporate Directors

Daniel L. Goelzer: Member, PCAOB

Judith Richards Hope: Audit Committee Chair, General Mills

Sherrill Hudson: Audit Committee Chair, Publix Supermarkets

Terry Iannaconi: Senior Technical Partner, KPMG LLP

James P. Liddy: U.S. Vice Chair, Audit, KPMG LLP

Mary Pat McCarthy: U.S. Vice Chair, KPMG LLP, Executive Director, KPMG’s Audit Committee Institute

Patrick S. McGurn: Special Counsel, Institutional Shareholder Services

George Muñoz: Audit Committee Chair, Marriott International

Charles H. Noski: Audit Committee Chair, Microsoft

Michael J. Passarella: Audit Committee Chair, Unum Group

David Y. Schwartz: Audit Committee Chair, Walgreen

Lawrence W. Smith: Member, FASB

J.W. Mike Starr: Deputy Chief Accountant, SEC

Richard G. Tilghman: Audit Committee Chair, Sysco Corp.

Rosalie J. Wolf: Audit Committee Chair, TIAA-CREF

Ann Yerger: Executive Director, Council of Institutional Investors

ISS is generally considered the most influential proxy advisor in the US. Recent studies have found that ISS is able to influence shareholder votes by 6 percent to 20 percent. [1] In preparing for 2012 annual meetings, corporate counsel, corporate secretaries and directors (particularly those serving on compensation or nominating and governance committees) should review the ISS policy updates and consider how the changes may affect ISS’ evaluation of director re-elections, executive compensation matters and other matters for shareholder vote. Note that for the 2012 proxy season, ISS has identified over 50 circumstances that may support a negative vote recommendation (either “against” or “withhold”) in uncontested director elections.

This article is an excerpt from a Weil Gotshal client alert, originally posted on the HLS Corporate Governance blog.

Summary of Key Changes for the 2012 Proxy Season

1. Revised Policy on Pay-for-Performance Evaluation
Under a revised policy, ISS has refined its methodology for determining pay-for-performance alignment.

Discussion: Previously, if a company in the Russell 3000 index fell in the bottom half of its GICS industry group in total shareholder return over both a one-year and three-year period, and CEO pay was not aligned with shareholder performance over time (with special emphasis on the immediately preceding year), ISS would recommend a negative say-on-pay vote.

Under the revised policy, ISS will select a narrower peer group of 12 to 24 companies, using as guidelines market cap, revenues (or assets for financial firms), and GICS industry group. Additional guidance on the new approaches for selecting companies for peer groups will be provided in December.

ISS will now focus on: (i) the relative alignment between CEO pay and company TSR within the peer group for a one- and three-year period (with a 40 percent emphasis on the one-year period and a 60 percent emphasis on the three-year period); (ii) the multiple of CEO pay relative to the peer group median, and (iii) the absolute alignment between CEO pay and company TSR over a five-year period. The system for evaluating differences in rates of change to identify weak or strong alignment will be provided in additional guidance to be issued in December.

Where the alignment is perceived to be weak, ISS will consider how a number of qualitative factors affect alignment of pay with shareholder interests, including:

• The ratio of performance- to time-based equity awards;
• The ratio of performance-based compensation to overall compensation;
• The completeness of disclosure and rigor of performance goals;
• The company’s peer group benchmarking practices;
• Actual results of financial/operational metrics, such as growth in revenue, profit, cash flow, etc., both absolute and relative to peers;
• Special circumstances related to, for example, a new CEO in the prior fiscal year or anomalous equity grant practices (e.g., biennial awards); and
• Any other factors deemed relevant.

Implications: Companies should study the additional guidance that ISS plans to issue in December and assess how their alignment of compensation and performance is likely to be assessed under ISS’ new methodology. Companies should take special care to focus their CD&As on the alignment between compensation and performance, and explain any anomalies.

2. Revised Policy on Board Response to Say-On-Pay Vote

Under a revised policy, ISS will recommend votes on compensation committee members and the current year say-on-pay proposal on a case-by-case basis where, in the previous year, the company’s say-on-pay proposal received the support of less than 70 percent of the votes cast.

Discussion: Previously, ISS would recommend a negative vote for compensation committee members “in egregious situations” or when the board “failed to respond to concerns raised in prior [management say-on-pay] evaluations.” When evaluating ballot items related to executive pay, ISS considered the board’s responsiveness to investor input and engagement on compensation issues (for example, failure to respond to majority-supported shareholder proposals on executive pay topics, or concerns raised in connection with significant opposition to prior year’s say-on-pay vote) on a case-by-case basis.

Under the revised policy, ISS’ case-by-case analysis will take into account: (i) the company’s response to the concerns expressed by shareholders in the previous year, including disclosed engagement efforts with major institutional investors and specific actions taken to address the issues that led to the “low” level of support, as well as other recent compensation actions taken by the company; (ii) whether the issues raised are recurring or isolated; (iii) the company’s ownership structure (for example, significant insider ownership); and (iv) whether the support level was less than 50 percent, which ISS notes will “warrant the highest degree of responsiveness.”

ISS has indicated that the new policy does not establish a bright line test, and that it may apply its case-by-case analysis to companies where the say-on-pay proposal received the support of more than 70 percent of the votes cast, including companies with significant insider ownership.

Implications: Companies whose say-on-pay proposal received a significant percentage of negative votes (even if the proposal was approved by more than 70 percent of the votes cast) should conduct outreach with their large institutional shareholders to discuss compensation concerns that contributed to negative votes and discuss what actions the board has taken, plans to take, or is considering in order to address these concerns (within the confines of Regulation FD). ISS notes that “these specific actions should ideally be new rather than a reiteration of existing practices.” In the CD&A, companies should consider disclosing efforts to engage with shareholders and consider their viewpoints (for example, the percentage of shareholders contacted). There may be instances where the board, after considering all relevant facts and circumstances with due care – including the shareholder say-on-pay vote – may decide that no change is appropriate. Where this is the case, the basis for this conclusion should be presented in the CD&A.

Note that shareholder outreach efforts on compensation concerns may be useful in avoiding a shareholder derivative lawsuit alleging that directors breached their fiduciary duties in connection with a failed say-on-pay vote.

3. New Policy on Board Response to Say-on-Pay Frequency Vote

Under a new policy, ISS will recommend that shareholders vote against or withhold votes from all incumbent directors if the board implements a say-on-pay vote on a less frequent basis than the frequency that received a majority of the votes cast. When no frequency received a majority, ISS will apply a case-by-case analysis if a particular frequency received a plurality of the votes cast and the board implements a say-on-pay vote less frequently.

Discussion: Last year, US corporate issuers were required to afford shareholders an advisory vote on the frequency with which the say-on-pay vote should be held, and will have to revisit say-on-pay frequency at least once every six years thereafter. Under a policy issued last year, ISS recommended voting for annual say-on-pay votes, rather than biennial or triennial say-on-pay votes. It appears that many large companies are opting for an annual say-on-pay vote.

Where a frequency option received a majority of votes cast and the board implements a less frequent say-on-pay vote, ISS will recommend that shareholders vote against or withhold votes from the entire board (except new nominees, who will be considered on a case-by-case basis). In a situation where no frequency received a majority of votes cast in support, and the board implements a less frequent say-on-pay vote than the frequency that received plurality support, ISS will take a case-by-case approach and consider additional factors in determining its recommendations, including the board’s rationale, the company’s ownership structure and vote results, any compensation concerns or history of problematic compensation practices, and the say-on-pay support level from the prior year.

Although ISS’ rationale for the new policy states that “[m]ajority support for a particular frequency should be viewed as a mandate to the board,” ISS will not issue negative vote recommendations where even though the shareholder’s “mandate” is for a frequency other than annual voting, the board implements a more frequent say-on-pay vote.

Implications: Companies that have disclosed they plan to implement a less frequent say-on-pay vote than the frequency option preferred by their shareholders should consider outreach efforts aimed at explaining why a less frequent say-on-pay vote is best for their circumstances. Some such companies may wish to revisit whether to implement the shareholder-preferred say-on-pay frequency.

4. Revised Policy on Incentive Bonus Plans and Tax Deductibility Proposals (Post-IPO Companies)

This year, ISS will apply a more rigorous analysis for the initial approval of equity plans under Section 162(m) of the Internal Revenue Code.

Discussion: Generally, ISS has recommended that shareholders support equity plan proposals solely for compliance with Section 162(m) of the Internal Revenue Code, due to the favorable tax deduction companies may take on performance-based compensation paid to named executive officers. Under the revised policy, ISS will evaluate, on a case-by-case basis, equity plans that are to be voted on for the first time following an IPO even if only for the purpose of obtaining favorable Section 162(m) treatment. ISS will perform a full analysis, taking into consideration total shareholder value transfer, burn rate (if applicable), repricing, and liberal change in control. If appropriate, ISS may also consider other factors such as pay-for-performance or problematic pay practices (such as perquisites).

ISS’ rationale for the policy update explains that the revised policy aligns with the recently proposed Treasury rule related to Section 162(m). The proposed rule would require newly public companies to obtain shareholder approval before awarding certain performance-based restricted stock units to named executive officers before the end of the standard post-IPO transition period to qualify as performance-based compensation.

Implications: Newly public companies seeking initial shareholder approval of an equity plan for Section 162(m) purposes should expect ISS to perform a full analysis and should not consider a favorable ISS recommendation to be a foregone conclusion. Companies should consider this policy change in both plan design and pay practices.

5. Revised Policy on Proxy Access

ISS’ revised policy expands and refines the factors it will consider in determining recommendations on proxy access proposals, and broadens the policy to apply to management proposals as well as shareholder proposals.

Discussion: Until now it had been ISS’ policy to recommend that shareholders vote case-by-case on shareholder proposals asking for proxy access, taking into account (i) the ownership threshold proposed in the resolution, and (ii) the proponent’s rationale for the proposal at the targeted company in terms of board and director conduct.

On September 20, 2011, the SEC’s amendment to Rule 14a-8 took effect, [2] providing that companies may no longer automatically exclude from proxy materials shareholder proposals seeking to amend company by-laws to require future inclusion of shareholder-proposed director nominees in company proxy materials on the ground that such proposals relate to director elections. Of course, companies may seek no action relief for exclusion of such proposals on other grounds pursuant to Rule 14a-8, and some companies may decide to pre-empt shareholder action through management proposals on proxy access.

ISS’ revised policy will apply a case-by-case approach to recommendations on proxy access proposals, taking into account a range of company-specific and proposal-specific factors, including: (i) the ownership thresholds proposed in the resolution, (ii) the maximum proportion of directors that shareholders may nominate, and (iii) the method of determining which nominations should appear on the ballot if multiple shareholders submit nominations. Because ISS supports proxy access in principle, the revised policy de-emphasizes the proponent’s rationale for the proposal. ISS has indicated that its company-specific review will focus on the company’s size and shareholder demographics, rather than the company’s corporate governance profile and practices. ISS has also indicated that its analysis of the appropriateness of the core features of proxy access proposals will be more exacting in the case of binding bylaw amendments than for precatory requests for board actions, since precatory requests permit boards an opportunity to review and revise the proposed procedures and thresholds for proxy access prior to adopting a policy.

ISS’ revised policy does not include any guidance on specific terms in a proxy access proposal that it considers to be favorable or unfavorable, noting that “the access debate is fluid and likely to gain more attention in 2012.” ISS’ executive summary of the updates, however, indicates that “[i]n January 2012, as part of [its] policy update process, ISS expects to provide additional guidance (via FAQs and/or through other reports) based on an examination of the specific proposal texts.”

Implications: It remains to be seen how frequently proxy access shareholder proposals will be brought, whether they will be structured as precatory requests for board action or as binding bylaw amendments, and the range of ownership thresholds proposed in the resolutions (i.e., percentage and duration). Companies should closely monitor proxy access shareholder proposals, as well as corresponding ISS recommendations and shareholder support. As of November 15, 2011, two precatory shareholder proposals seeking proxy access had been filed by Ken Steiner, an individual shareholder involved with the U.S. Proxy Exchange (USPX), a coalition of individual retail shareholders. The proposals, submitted to Textron and MEMC Electronic Materials, were the first 2012 access proposals to be publicly disclosed. The Steiner proposals (which are substantially identical) provide a lower threshold of stock ownership for shareholder nomination of directors than that contemplated by the SEC’s vacated Rule 14a-11, which required ownership of three percent of a company’s outstanding shares for a period of three years in order to nominate one or more director (with a 25 percent cap). The Steiner proposals recommend that the company’s proxy include nominees of “any party of one or more shareholders that held continuously, for two years, one percent of the Company’s securities eligible to vote for the election of directors” or any party of 100 or more shareholders that satisfy SEC Rule’s 14a-8(b) eligibility requirements ($2000, or one percent of a company’s securities eligible to vote, continuously held for at least one year). Companies and boards should follow these developments closely.

Nora McCord

However, the cost of losing a say-on-pay vote is high. In addition to the obvious reputational damage, recent court decisions have indicated that these companies face a very real threat of lawsuits, as well as the potential for future “withhold” vote campaigns against directors.

There are also indications that the upcoming proxy season may not be as straightforward as the last. Recent economic volatility may negatively affect corporate performance, rhetoric against excessive executive compensation is on the rise, and voting methodologies for proxy voting advisory firms and others are expected to change but are currently unknown. For all of these reasons, the cost of “getting it wrong” has never been higher.

The good news is that we now know a great deal more about how to design an effective shareholder outreach program. Below are five recommendations for companies developing shareholder outreach programs to secure favorable say-on-pay votes.

1. Prioritize outreach efforts. When communicating with shareholders, companies should prioritize those who voted against say on pay. Additionally, understand the impact proxy voting advisory firms may have on the vote, and be sure to include them in outreach efforts if they influence a meaningful percentage of the vote.

2. Time conversations well. While many shareholders are open to greater dialogue with portfolio companies, the timing of these conversations matters. Everyone is busy during proxy season. Shareholders appreciate off-season meetings, which permit more thoughtful discussions. To avoid shareholder fatigue, if possible, schedule meetings in the early to midsummer, rather than late fall. That said, addressing compensation in discussions with shareholders throughout the year is probably the best approach.

3. Don’t assume shareholders have read your entire CD&A. CD&As are longer than ever before, and many companies appear to have focused on providing more information rather than ensuring the right information is presented in the most compelling format. In our experience this is a critical distinction. In followup meetings this summer, the number of shareholders reporting that they have not read the entire proxy is surprising, even in preparation for an off-season meeting.

4. Draft a strong executive summary for your CD&A. The executive summary should convey the entire pay-for-performance story and include everything necessary to ensure a positive say-on-pay vote. It should cover the basic aspects of the program, the rationale for any elements that might be viewed negatively by shareholders, an overview of company accomplishments and related pay decisions, and a summary of pay and governance best practices in place at the company.

The executive summary should function as a stand-alone document that can be used in face-to-face meetings with shareholders and posted in the investor relations section of the company’s website. Conversations with some major shareholders suggest that they will look for and rely upon this material if it is available.

5. Listen to your shareholders. Listening to shareholders is just as important as educating them. In our experience, the say-onpay vote is a relatively blunt instrument. Face-to-face dialogue with shareholders often provides valuable insight into what really matters to them. For example, some shareholders vote against companies simply because they grant options or provide gross-ups, regardless of the rationale, while many shareholders vote automatically inline with the recommendation of their proxy voting advisory firm. Often, knowing exactly what drives votes, and how strongly held the views are, can only be garnered through in-person conversations.

To be effective, shareholder engagement must become a year-round endeavor. Once an anomaly, regular and candid engagement with shareholders is rapidly becoming the norm. With proper planning, say-on-pay votes will never be a surprise.

Nora McCord is a managing director of Steven Hall & Partners.

Roger A. Lane

Section 14A specifically provides that these resolutions will not: (i) overrule the board’s compensation decisions or (ii) create or imply any change to or any additional fiduciary duties for the issuer or board.

Despite Congress’ disclaimer of new or enhanced fiduciary duties, several companies are now facing derivative lawsuits following stockholder rejection of board-approved compensation plans. At least seven companies are facing derivative suits (and in many instances, more than one such suit), and plaintiffs’ class action/derivative firms have announced investigations of additional companies. Many of these suits are still in their infancy, and, as a result, it is unclear how much traction the suits will ultimately have. At least one such suit, however, has already resulted in a monetary settlement. In March 2011, KeyCorp, after being sued under a similar provision found in the Troubled Asset Relief Program (TARP), agreed to make changes to its compensation practices and procedures and to pay $1.75 million to the plaintiffs’ law firms. The potential of achieving similar settlements will likely encourage the plaintiff’s bar to continue to pursue such suits — at least until some of the cases are dismissed, or otherwise work their way through the courts.

The derivative lawsuit filed against the board of directors of Helix Energy Solutions Group (Helix) and its compensation consultant illustrates the types of allegations made in these lawsuits. As a consequence, the Helix lawsuit can be used to provide guidance on how companies might avoid drawing similar litigation, or at least better position themselves to defend against such claims.

Courtney Worcester

In its 2011 proxy statement, Helix’s board unanimously recommended that its stockholders approve its 2010 executive compensation. The complaint alleges that despite the assertion in Helix’s proxy statement that “[w]e have a pay-for-performance culture,” Helix instituted pay raises for executives (primarily by increasing stock awards), despite the company’s poor financial performance in 2010. The complaint alleges that in 2010, net revenue declined 17.9 percent, gross profits fell 86.2 percent, and earnings per share swung from a positive $1.01 in the prior year to a negative $1.22. A substantial majority of Helix’s voting stockholders — more than 66 percent — rejected the board’s recommendation and voted against Helix’s 2010 executive compensation. Following that vote, Helix’s board adopted performance metrics for 2011 cash incentive bonuses, but did not change the 2010 executive compensation.

Less than a month later, a stockholder derivative suit was filed against Helix’s current and former directors, certain executives and Helix’s compensation consultant. The Helix complaint includes a claim for breach of the fiduciary duty of loyalty against the company’s current directors, a claim against the recipients of the pay raises for unjust enrichment and a claim against Helix’s compensation consultant for aiding and abetting breaches of fiduciary duty.

Most interesting, the Helix complaint contends that the negative stockholder vote is sufficient, in and of itself, to rebut the presumption of the business judgment rule and put the burden on the defendants to prove that their actions were appropriate. As most directors and their advisors are aware, the business decisions of corporate directors are generally entitled to the protection of the business judgment rule, which precludes courts and stockholders from second-guessing such decisions. According to the plaintiffs, however, the stockholder “no” vote constitutes “direct and probative evidence” that the directors’ 2010 executive pay decisions were not in the best interests of Helix’s stockholders. The plaintiffs claim that this alone overcomes the business judgment rule and shifts the burden to the defendants to prove that the challenged compensation decisions were made in good faith and in the stockholders’ best interests.

It is, to put it mildly, unclear how a nonbinding stockholder vote that, by its terms, was not to be construed to overrule the board’s compensation decisions, or to impose any new or enhanced fiduciary duties on the board, can be sufficient in and of itself to defeat the business judgment rule. However, in light of the KeyCorp settlement, companies who face a potential “no” vote on executive compensation should recognize that they could be targets of similar litigation — an experience that is inherently costly and distracting, regardless of the merit or lack of merit of the claims. While one cannot categorically prevent a lawsuit from being filed, companies can take steps that may reduce the risk of such suits.

Know Your Constituents
Does the board have a sense of whether the company’s principal stockholders will approve or reject the company’s executive compensation? Long before any vote takes place, the board may wish to consider factors such as the following to assess the risk of a stockholder “no” vote: Have significant institutional investors — the parties who drive these votes — indicated in the past that they are unhappy with the company’s compensation practices or decisions? Have any of these same institutions “no” voted other companies or filed suit, and if so, do we know why? Are there aspects of the company’s recent performance that a stockholder could seek to characterize (rightly or wrongly) as “disappointing”? If so, how do those aspects factor into the company’s compensation philosophy and decisions? Are there steps that the company can take, by way of additional communication, disclosure, or the like, to address these risk factors proactively and render it more likely that the plan will obtain a positive vote?

Be Prepared
If there is genuine risk of a stockholder “no” vote, companies may wish to consider having a plan in place to address the issue. Will the compensation committee revisit a rejected compensation decision and consider adjustments to it, or will adjustments be considered on a prospective basis only? What are the tax, accounting, and other ramifications of a retroactive adjustment, and are they problematic? Does a decision to make adjustments depend on the percentage of stockholders that vote against the plan (e.g., 51 percent versus a supermajority) or other factors? If no adjustments will be made, will the company provide an explanation of why it is maintaining a decision that the stockholders have rejected? As a matter of good corporate housekeeping, the minutes of compensation committee and board meetings should, of course, capture and accurately convey the rationale for any action or non-action that the compensation committee and board decide to take in light of a negative stockholder vote.

Helix provides a cautionary example. Two days after receiving a negative stockholder vote on its 2010 executive compensation, Helix stated in a May 2011 8-K that, “the Compensation Committee of the Board of Directors values the opinion of our shareholders and as a result has determined to take the following actions: (i) implement defined performance metrics for the 2011 Cash Bonus Program for executive officers with the Committee, however, retaining overall discretion with respect to the grant of individual awards made under the program, and (ii) modify the long-term incentive compensation awarded to executive officers to include additional pay for performance elements in future grants.” One month later, in a June 2011 8-K, Helix announced the performance metrics it had adopted for 2011 cash bonuses. Apparently not satisfied with such prospective measures, the stockholders proceeded to file suit.

Review Your Disclosures
Consider explaining what the company means by terms such as “pay for performance.” In lawsuits challenging decisions to proceed with stockholder-rejected compensation plans, the plaintiffs’ bar often seeks to use the Compensation Discussion & Analysis (CD&A) section of the proxy statement to support their claims. The Helix complaint again provides a useful illustration. There, the plaintiffs point to language in the CD&A stating that executive pay is based on performance. Then, the plaintiffs point to a decline in the company’s performance and allege that despite the decline, the company increased the compensation of its executives, and did so notwithstanding the “no” vote of its stockholders. On this basis, the plaintiffs assert that the company is not, in fact, paying executives based on the company’s performance, and the plaintiffs charge the directors with ignoring the company’s compensation policy.

This type of argument, and its superficial appeal, are based on the latent ambiguity in common, everyday terms that may not be defined or described in detail in the CD&A. As a result, companies should consider explaining in the CD&A whether “pay for performance” means that pay is based solely upon total shareholder return, or whether “pay for performance” takes into account other considerations or metrics. Disclosing what goes into executive compensation decisions may not convince stockholders and their lawyers not to sue, but it can reduce the “field of play” on this issue and provide defense counsel with more robust disclosures to use in defending against these claims, including in seeking to have the claims dismissed at the outset.

Potential Impact on Compensation Advisors
As the complaint against Helix and other, similar complaints show, the plaintiffs’ bar is pursuing claims not only against corporate directors and officers, but also “aiding and abetting” claims against compensation advisors. As a result, companies should review whether, and to what extent, they have indemnification obligations to their compensation advisors; whether such obligations are insured; and what impact a lawsuit might have on the relationship between the advisor and the company. In addition, if compensation advisors perceive a genuine risk of regularly becoming defendants in lawsuits, they may well seek additional indemnification or an increase in their fees, and they also may charge higher fees to companies that have received negative stockholder votes.

It should be noted that “aiding and abetting” claims are not, generally speaking, a favored type of claim. Thus, whether these issues ultimately prove to be significant or not depends in large part on how the courts treat these claims in the current raft of “say-on-pay” lawsuits.

About the Authors
Roger A. Lane is a partner in law firm Foley & Lardner’s Securities Enforcement & Litigation Practice. He has significant experience representing clients involved in complex commercial litigation, with a particular emphasis on corporate law disputes, stockholder and federal securities litigation, and related risk management issues. Lane can be reached at (617) 342-4098 or rlane@foley.com.

Courtney Worcester is senior counsel in the Boston office of Foley & Lardner. Her practice focuses on complex commercial litigation involving corporations, venture capital and private equity firms, financial institutions and their directors and officers. Worcester can be reached at (617) 502-3218 or cworcester@foley.com.

Beazer Homes, Hercules Offshore, Umpqua Holdings and Jacobs Engineering also face say-on-pay suits following failed votes. Occidental Petroleum and KeyCorp settled similar litigation. In both the pending and settled suits, the compensation advisors are named as defendants along with the board and compensation committee.

Reacting to the lawsuits, Farient Advisors Executive Chair Robin Ferracone said, “I’m not sure that these results are all that positive.…We’ll continue to provide objective, independent advice. I don’t think the advice will change.”

“What is surprising to me is that some of my clients have told me that their executive compensation consultants have asked the company to indemnify them for their work—and they never will,” said Jack Lederer, principal at Curcio-Webb, where he directs the Executive Compensation Advisory Services Practice. In fact, Lederer believes that these sorts of suits will increase in coming years. “There are three points of influence: the shareholders, the compensation committee and management,” he said. “What [compensation consultants] need to do is make the tension between the three points livable and positive.”

Say-on-Frequency Votes
With few exceptions, companies have issued formal recommendations to shareholders that future “say-on-pay” votes be held annually, biennially or triennially. Early in the 2011 proxy season, the trend was toward recommending triennial votes. But as large institutional investors and major proxy advisory groups (e.g., ISS Governance Services, Glass Lewis) expressed a strong preference for holding annual votes, more companies began recommending them. As of July, 51 percent of companies had recommended annual say-on-pay votes, versus 44 percent for triennial votes, with the remaining companies either for biennial votes or not making any recommendation.

Overall, 73 percent of all shareholder votes followed the company’s recommendation on frequency. However, 99 percent did so when the company endorsed an annual vote. More than 50 percent of the time, shareholders voted with a company’s triennial recommendation. This may be indicative of shareholders not following proxy advisor recommendations or agreeing with arguments that a vote every three years would be less administratively burdensome, be consistent with the compensation planning cycle and allow sufficient time to address shareholder concerns.

“Say-on-Pay” Votes
Overwhelmingly, shareholders have supported the executive pay packages in say-on-pay votes. Of the 2,732 shareholder votes held by early July, nearly 99 percent received positive outcomes, with only 37 companies failing to win majority shareholder support. While there’s no distinct size or industry profile among the companies with negative voting outcomes, the consumer discretionary industry and midsized companies ($500 million to $5 billion in revenues) have been most prone.

Despite the high level of shareholder support, say on pay has had an influence on programs. Most companies took action well in advance of votes to address known shareholder concerns and avoid negative votes. Others were making changes and defending themselves against criticism up to the last minute. For example, more than 50 companies filed public rebuttals against negative recommendations from proxy advisory firms.

Lessons From Year One
There were several notable issues among the small minority of companies that received a relatively high percentage of dissenting votes from shareholders to date. They include:

• Low Total Shareholder Return (TSR): 31 of the 37 companies that received a negative vote had one- or three-year TSR below their industry medians.
• Pay-for-performance disconnect: Year-over-year CEO compensation increased, while company performance lagged industry peers.
• “Red flag” compensation: The company had controversial pay practices such as newly adopted excise tax gross-up provisions in change-in-control agreements.

Clear Impact on Outcomes
The voting recommendations by ISS have had a clear impact on outcomes. ISS has recommended against say-on-pay proposals at more than 300 companies, including all 37 say-on-pay vote failures. Shareholder approval rates averaged 68 percent for companies that ISS recommended “against,” and 92 percent among companies that ISS recommended “for.” Further, no company that received a positive recommendation from ISS has failed to receive majority shareholder support.

Companies that ignore the say-on-pay message delivered by shareholders risk continued dissatisfaction, possible voting campaigns against directors or even legal action. Instead, companies can use the votes and the information they gather to improve communications with shareholders and, ultimately, ensure programs are understandable, appropriate and effective.

Michael Enos is managing director of Pearl Meyer & Partners in Boston.

Ted Dysart

There are numerous issues that have come to light over the last couple of years (and some which have been raised for decades) with regard to Corporate Governance and an overall feeling of hurry up and wait. Proxy access seems to be on the minds of many especially with the court ruling against the SEC, and the SEC deciding not to appeal. But this is not the end of the road for proxy access debate; in fact, the debate is on-going. SEC Chairman Mary Schapiro has made it clear that her intent is to find a way for shareholders to have an equal say in director nominations and will not be backing away from the issue. The arguments are passionate on both sides and there doesn’t seem to be an easy resolution. Regardless of the official regulations, companies need to take a look at their own practices and make sure they are working toward an amicable balance between what is right for the company and what the shareholders are demanding. We are seeing many companies enacting their own best in practice regulations with regard to this issue which clearly lay out who can have access, what the protocol is for submitting material to be included in the proxy and what type of communication shareholders can expect with regard to submissions. The reality of today is this: Shareholders want to be heard and boards had better (at the very least) listen.

Another topic that gets a lot of press is say on pay, which remains a divisive topic. It seems to be a subject that is always put in the spotlight when the economy is not as strong as investors and the public at large would like it to be. It is also a favorite topic in the media, especially when there is a shakeup at a company. Investors always want their money to be used wisely, and having a say on pay is part of that equation. Should top executives get flat rate pay with a predictable bonus structure based on performance, or is there room to reward and penalize based on performance and health of a company? And what about change-in-control compensation? More importantly who decides? Do you trust your board to make the right decision for the company and put personal feelings aside when it comes to appropriate pay decisions? And how often should votes take place for both say-on pay itself and the frequency of those votes which the SEC says should be revisited every six years. Will we lose great leaders to companies overseas that can and will pay more without the intrusion of the government and shareholders?

It is important to note that Dodd-Frank was almost 850 pages and requires more than 240 rule makings and nearly 70 studies. By comparison, Sarbanes-Oxley was 66 pages long and mandated 16 rule makings and just 6 studies. It should go without saying that there is still a lot of legal red tape and issues to be sorted out which will take years and billions of dollars. While the major impact of Dodd-Frank has yet to be felt we can look and wonder about those issues that have surfaced. Will the whistleblower protection remain unchanged? Will there be more reform with regard to background disclosures for board nominations? Whatever side you find yourself supporting on the various legislative issues, it is clear that companies need to keep a close eye on the issues and continue to organize their board to fit the needs of all interested parties— government, shareholders, executives and employees.

Theodore L. Dysart is a vice chairman with Heidrick & Struggles where he is a leader in the global Board of Directors Practice.

Images.com

Speaking at the NACD’s recent National Compensation Advisory Council, Robin Ferracone, executive chair of Farient Advisors, an executive compensation and performance consulting firm, said that while the challenge of evaluating and setting CEO and executive compensation is becoming more of a lightning rod, companies that can pass the “red-face test” will have a relatively easy time with the new disclosure and say-on-pay rules. Those that cannot may be treated harshly.

Those attending the meeting highlighted several issues that need to be addressed, both in the fundamentals of setting pay and in the way those pay decisions are communicated to shareholders and to the wider community. Perhaps the most important questions to emerge from the discussion were: Why are some CEOs pilloried for their compensation while others—even those who may make more— are held up as heroes? There is little, if any, consequence for underperformance—in fact, CEO pay never seems to go down. How should directors really measure performance, and how can compensation structures and policies be best communicated to shareholders, the media and the general public? Until these issues are addressed, there can be no meaningful discussion of the role of the compensation committee.

Some participants questioned the premise that the compensation system is “broken,” and even the need to have the conversation. Why is such a dialogue important, they asked?

Ken Daly, NACD president and CEO, answered succinctly: “If we don’t do something about this, then Congress will do it for us. If directors only do what is mandated [in terms of curtailing CEO pay], then we are going to get stronger regulation. Up to this point Congress has generally been happy changing behavior by increasing disclosure, but their patience has run out and they are starting to take a far more aggressive approach. If we don’t get ahead of issues and concerns around compensation— real or perceived—then we will lose control of the discussion.” In short, regulatory overtone is filling the gap in board leadership.

Several hours of sometimes-heated conversation resulted in a handful of steps and resolutions that boards should take in order to take control of the issue and become leaders of compensation strategy.

1. The board must be the leader of the compensation process. While in theory it is the job of the compensation committee (and ultimately the entire board), in reality, many boards feel that the CEO dominates the conversation while the board is reduced to a reactionary role.

The board needs to regain primacy on compensation philosophy, metrics and planning. The compensation committee must set the tone and own the process. This may require the compensation committee to adopt a different tone or approach than other committees that provide oversight and work collaboratively with management. The compensation committee should be less collegial, and realize that this is one of the few areas in which it has total responsibility. They shouldn’t act like dictators but, as one chairman pointed out, “You should remember that the CEO is really just an employee. This will assist greatly in setting the tone for compensation conversations.”

2. Tie pay to performance and define the metrics. Ferracone cautioned that assessing pay and performance is tricky. Perhaps the most common mistake made is looking at the grant value of long-term incentives rather than the value of long-term incentives after performance has happened. To achieve the Holy Grail of pay—i.e., tying it to long-term performance— use forward-looking metrics rather than backward-looking responses to past performance. The board should conduct a robust discussion of how pay aligns with strategy. This should be a formal agenda item. Nonfinancial metrics should also be considered because they can have a tangible impact on both short- and long-term value. Broaden the scope of what is considered value creation and sustainable growth. Consider the impact the company has on the wider community. Some companies are including metrics such as workplace safety, reliability of service and customer satisfaction.

Stephen Brown, director of corporate governance at TIAA-CREF, suggested linking any increase in CEO pay to pay within all levels of the organization. “You could match the CEO compensation story with employees, shareholders and others,” he said. “If CEO pay goes up 20 percent but general employee pay only goes up 2 percent, you are likely to have a problem.” In other words, it can be very difficult to justify this type of increase, not just to the media but also to the workforce.

The board must also create a structure that outlines negative consequences for poor or nonperformance. Variability in executive pay is acceptable. The compensation committee should not be constrained by legacy metrics. It is easy to get trapped in a steady stream of upwardly ratcheting pay—CEO pay never really seems to go down. Noted Arthur Martinez, director at AIG, PepsiCo, IAC/Interactive, Liz Claiborne and International Flavors & Fragrances, there is a “lack of true variability in pay at top levels. It is very hard to have the conversation that we can’t tell them their bonus will be 75 percent lower than last year. CEOs don’t always take that well. It’s the responsibility of those of us on committees to have that discussion and to introduce a real sense of variability.”

Yonat Assayag

With the 2011 proxy season behind us, we examine what influence the pay-and-performance relationship has had on say-on-pay votes and consider what we have learned as we look ahead to 2012 compensation decision-making.

Say-on-Pay Voting Results Among the First 100
Among the First 100, all but two companies – Jacobs Engineering and Hewlett-Packard – garnered a majority of shareholder votes in favor of their executive compensation program. On average, 89 percent of shareholders voted in support of executive compensation programs, and 66 of the 100 companies received support from more than 90 percent of shareholders.

Results for the First 100 are very consistent with voting results in the broader market. As of Aug. 12, 2011, approximately 2,600 companies held say-on-pay votes; 37 companies (including Jacobs Engineering and Hewlett-Packard) failed to win majority shareholder support – less than two percent. A study of Russell 3000® companies indicates that almost 75 percent of companies passed say-on-pay votes with more than 90 percent shareholder approval.

Influence of Performance on Say-on-Pay Votes
Performance, as measured by total shareholder return (TSR), has a significant influence on the shareholder vote. As shown in Table 1, companies with stronger TSR on a one- and three-year basis were more likely to get “for” votes from shareholders on their executive compensation programs.

Russell Miller

Not surprisingly, as shown in Table 2, average TSR among those companies that failed to win majority shareholder support for their say-on-pay votes was significantly below the broad market (based on the S&P 500), further supporting the conclusion that performance matters.

Influence of the Pay-and-Performance Relationship on Say-on-Pay Votes
The results of the first say-on-pay votes send a clear message that performance matters, and that pay that is disproportionate with performance can result in a negative vote, particularly if pay is high and performance is low.

An analysis of CEO total compensation and TSR for the First 100 finds a relationship between CEO pay, company performance and say-on-pay votes. Companies that paid their CEO in the top quartile of all companies in the First 100, but had one-year TSR that was in the bottom quartile (i.e., the companies that paid high and performed low), on average, had the lowest level of shareholder support for their executive compensation program. Also noteworthy, First 100 companies in the top quartile for TSR received, on average, more than 90 percent shareholder approval on say on pay regardless of how the CEO was paid. Conversely, companies in the bottom quartile for TSR performance received, on average, less than 90 percent shareholder approval, regardless of CEO pay.

Alignment between pay and performance appears to have influenced votes for the 37 failed say-on-pay companies as well. For most of these companies, the rationale for failing to receive majority shareholder support for their executive compensation programs was due to:

• A perceived pay-and-performance disconnect (e.g., CEO pay increased in a period where TSR was negative or below the median of a comparator group), or
• Significant concern among shareholders about non-performance based pay (e.g., large severance packages, excise tax gross-ups or tax gross-ups on perquisites).

Influence of Program Design on Say-on-Pay Votes
Institutional investors and shareholder advisory groups are paying considerable attention to ensuring that companies limit non-performance-based pay elements and enhance shareholder alignment (e.g., eliminating executive perquisites and increasing stock ownership guidelines). In a study conducted by ClearBridge Compensation Group earlier this year, we noted many First 100 companies made changes to their compensation program aimed at enhancing the relationship between pay and performance in preparation for their first say-on-pay votes.

Despite this focus, there is little evidence, based on the results of the First 100 say-on-pay votes, that any one compensation practice had any significant influence on the outcome of the shareholder votes. A study of four compensation practices that are often a focal point by shareholders and advisory groups – excise tax gross-ups, perquisites, stock ownership guidelines and clawbacks – indicates that say-on-pay votes for companies with those pay practices did not significantly differ from companies without them. While these practices individually do not seem to influence the say-on-pay vote, when combined with other shareholder concerns (such as a pay and performance disconnect), there is the potential for these practices to swing the vote.

Another effect of say on pay has been an increased level of engagement with shareholders. Early in the proxy season, companies recognized the importance of knowing their shareholder base and understanding fully their perspectives on compensation and governance issues.

Determining when and how often to reach out to investors is a strategic decision companies should make each year. During this proxy season, a significant number of companies determined that engagement with shareholders following an “against” vote recommendation from proxy advisory firms (e.g., ISS and Glass Lewis) was critical to overcoming the negative recommendation. Among the First 100, seven companies, including Disney, Hewlett-Packard and J.C. Penney, filed supplemental materials following ISS’s negative recommendation, in large part to defend their pay-for-performance orientation. This approach proved successful in swaying shareholder votes for many companies, providing further evidence that effective communication of the pay-for-performance story can influence shareholder votes.

Influence of Disclosure on Say-on-Pay Votes
Effective disclosure had a clear impact on the say-on-pay votes. Companies that used a “layered” approach with an executive summary – highlighting key program design features and pay/performance alignment early in their CD&A, with supporting detail provided in later sections – enjoyed higher say-on-pay results as compared with those companies that did not. Seventy-one percent of First 100 companies that used executive summaries received “for” votes from 90 percent+ of shareholders. In contrast, of the companies without executive summaries, only 57 percent received FOR votes from 90 percent+ of shareholders.

A Look Ahead to 2012
Much can be learned from the 2011 proxy season and can be incorporated into compensation decision-making for 2012. A design that fully supports the business, aligns with shareholder interests, and is sensitive to shareholder perspectives is critical to the success of any executive compensation program. Companies should consider the following with respect to their compensation programs:

1. Establish a transparent link between pay and performance. Successfully demonstrating the pay/performance linkage is critical to gaining majority support of the executive compensation program. In particular, companies should:
   1. Identify the key measures of the company’s success;
   2. Determine how to assess actual performance (for example, should performance be compared to budget, relative to peers or some combination of both?); and
   3. Determine how to assess pay (for example, should it reflect grant values or realizable gains?) and understand what influences pay.
2. Aim to minimize non-performance-based pay and enhance shareholder alignment. While doing so may not be the primary driver for say-on-pay vote outcomes, it can signal to institutional shareholders and advisory firms that the company takes pay for performance and shareholder alignment seriously.
3. Engage with Shareholders. Proactive outreach to shareholders heavily influenced SOP voting outcomes this proxy season. Talk with top investors early in the season to gain insights on their compensation governance policies and their views of the company’s pay practices. Pay attention to proxy advisory firms’ influence, but also know that an “against” recommendation often does not translate into a failed say-on-pay vote.
4. Use proxy disclosure to your advantage. Companies that use proxy disclosure to tell their story and incorporate user-friendly formats such as executive summaries and charts can provide clear understanding of their compensation decisions and effectively demonstrate the pay and performance relationship.

Applying what has been learned from the first year of say on pay and making informed decisions on the executive compensation program going forward will result in effective compensation programs and positive say on pay outcomes in 2012 and beyond.

Yonat Assayag and Russell Miller are partners at ClearBridge Compensation Group, an independent executive compensation consulting firm based in New York City. They can be reached at yassayag@clearbridgecomp.com, and rmiller@clearbridgecomp.com.

Results of General Vote. As of May 6, all but 15 of the 807 companies that have reported results with respect to their say on pay votes have received favorable votes, with over 2/3 of companies receiving more than 90 percent favorable votes.

Jeremy L. Goldstein

Influence of Proxy Advisory Firms. The recommendations of Institutional Shareholder Services (ISS) have had a measurable impact on voting results. ISS has recommended against say on pay proposals at approximately 12 percent of companies holding such votes. Of companies receiving unfavorable vote recommendations from ISS, 11 out of 60 that reported results as of April 29 failed to receive majority support. Companies receiving negative ISS recommendations that have nonetheless passed have generally done so with considerably lower margins than those receiving favorable vote recommendations. No company receiving a positive recommendation from ISS has failed to receive a majority support.

The influence of Glass Lewis, the other major proxy advisory firm, appears thus far to have been minimal. Glass Lewis has recommended against a strikingly high percentage of companies, and perhaps for this reason, has influenced voting results by approximately three percent or less. In our experience, many companies have determined not to address directly criticisms raised by Glass Lewis.

Editor’s Note: Jeremy Goldstein is a partner at Wachtell, Lipton, Rosen & Katz, active in the firm’s executive compensation and corporate governance practices. This post is based on a Wachtell Lipton firm memorandum, and originally appeared on The Harvard Law School Forum on Corporate Governance and Financial Regulation blog.

Reasons for Negative Vote Recommendations. In approximately 85 percent of the situations in which ISS has recommended a vote against say on pay, it is because ISS believes there is a “pay for performance disconnect.” A “pay for performance disconnect” generally exists if both one-year and three-year total shareholder return are in the bottom half of the company’s GICS industry group and the total compensation of the CEO as reported in the summary compensation table is in ISS’s view not aligned with total shareholder return over time. Most frequently, the disconnect is found to exist if there is an increase in year-over-year compensation of the CEO.

ISS may also recommend against a say on pay vote if the company has engaged in so-called problematic pay practices. In our experience, problematic pay practices generally result in an unfavorable vote recommendation only in those circumstances that ISS deems “egregious.” Such circumstances most commonly include (1) option repricings without shareholder approval, (2) excessive perks or gross-ups or (3) entry into new or extended agreements that provide for “golden parachute” excise tax gross-ups or single trigger severance payments (such gross-ups are probably the most common reason that ISS provides a negative recommendation due to a problematic pay practice).

Problems with the ISS Methodology. ISS’ methodology is problematic for several reasons. First, it is a “one size fits all” test that does not accurately take into account the different needs and goals of different companies and focuses on form over substance in executive compensation. Second, the peer group used by ISS to determine whether a particular company is performing well is the GICS group, which often bears little to no relation to the peers against which a board might assess corporate performance for many reasons, including the size of the GICS group and the varied size of the companies comprising the group. Third, ISS only looks at compensation as reported in the summary compensation table, a blunt instrument that can result in widely different results for companies paying executives in different forms. For example, a stock award based on the achievement of performance goals will generally appear in the summary compensation table in the year of grant, where a cash award will only appear, if at all, in the year in which the performance goals are achieved and the award is paid. As a result, a company might pass or fail ISS’ pay for performance test based solely on the form – cash or stock – of the award. Fourth, ISS does not consider time-based stock options or restricted stock as performance-based compensation. In addition, ISS’ TSR statistics are annual – not compounded – and are derived from a third party source. If the third party gets it wrong, then ISS gets it wrong and makes no further inquiry or changes. Moreover, because of ISS’ focus on one and three year TSR, companies that managed well through the financial crisis have been, and will for the next few years be, at a disadvantage in the relative TSR test. Finally, and perhaps most importantly, ISS has never offered evidence that the practices that they seek to prevent adversely affect corporate performance or shareholder returns. In fact, a recent Stanford University study demonstrates that ISS’ position on option exchange programs decreases shareholder value.

How to Win the Vote. If ISS recommends in favor of a company’s say on pay vote, there is little that needs to be done to ensure that shareholders will vote in favor of the company’s compensation arrangements. If, however, ISS recommends against the say on pay vote, there are several actions that a company may wish to consider taking to help ensure a successful result.

• Understand How Compensation Programs Stack Up Against ISS Standards. While there is no need to conform executive pay practices to ISS standards, companies should understand where their practices deviate from ISS standards and be prepared to explain why their practices deviate.
• Assemble a Task Force. ISS usually provides companies with a draft copy of its recommendations 24 hours in advance of making the recommendation. To be in a position to timely respond, companies should anticipate the likely timing of the release of the draft report, assemble a task force in advance of its receipt and ensure that task force members will be available to respond to the report. In preparing for the report, companies should be aware that ISS may issue the draft report over the weekend.

Yonat Assayag

New federal regulations under the Dodd-Frank Act require companies to hold non-binding shareholder votes on their executive pay programs (say on pay), the frequency of future say-on-pay votes (say on frequency) and golden parachute payments in the event of a transaction (say on golden parachutes). The say-on-pay and say-on-frequency votes are required for all publicly-traded companies with annual shareholder meetings held after Jan. 21, 2011.  The say on golden parachutes requirement is effective for proxies filed on or after April 25, 2011.  Smaller reporting companies (less than $75 million in public float) are granted a two-year delay until these votes are effective.

As the proxy season progresses and say-on-pay vote results filter in, new learnings for boards continue to surface. One theme is clear: companies that perform, and successfully demonstrate that their pay programs support and drive performance, are more likely to win shareholders’ votes.

Program Changes

Russell Miller

This year’s filings indicate that in 2010, companies focused on minimizing non-performance-based pay and enhancing shareholder alignment:

• Excise tax gross-ups: Nearly 40 companies, including companies such as AT&T and OfficeMax, eliminated excise tax gross-ups (either from existing or future arrangements).

• Severance multiples: Three companies reduced severance multiples for the CEO from 3x cash compensation to 2x cash compensation.  Six companies have a policy requiring shareholder approval of any payouts greater than 2.99x cash compensation, including one company (Bank of New York Mellon) that adopted the policy in 2010.

• Clawbacks: Of 79 companies disclosing clawback provisions for their named executive officers, 34 adopted or enhanced these provisions recently.

• Ownership guidelines: While CEO stock ownership guidelines of 5x salary is most common among the first 100 companies (45 companies), a growing number of companies are increasing their guidelines beyond 5x.  In 2010, six companies increased their guidelines from 5x to 6x, resulting in 24 total companies with guidelines greater than 5x.

The first 100 companies focused their disclosure on their pay-for-performance story:

• Many companies took a “layered” approach and highlighted key program features and the alignment between pay and performance early in their disclosure.
  • Prevalence of executive summaries more than doubled, from 30 companies last year to 64 companies this year.  Companies focused their executive summaries on their pay-for-performance relationships, often enhancing disclosure from 2009 through graphical representations of pay and performance.
  • A few companies, including General Electric, took this disclosure a step further by including a summary of the compensation program and why shareholders should vote for it at the very beginning of the proxy statement.  This disclosure focused primarily on 2010 compensation decisions and 2010 company performance.

• Several companies, including Kimberly Clark and Lockheed Martin, enhanced their pay-for-performance discussion by adding a comparison of Total Shareholder Return (TSR) vs. CEO pay at the beginning of the CD&A.   This level of disclosure may be a preview to the pending pay/performance disclosure requirement under Dodd-Frank, which won’t likely be effective until 2012.

• Some companies have re-introduced the proxy performance graph, which compares the company’s TSR to TSR of an index and peers over a multi-year period and is now required 10-K disclosure.  Variations of this performance graph were included in proxy statements for BB&T, Goodrich Corp and Honeywell International.

• While companies discussed their performance in terms of various financial, operating, and stock-based measures, graphical analysis of performance tended to focus on TSR.  However, some companies, including Eli Lilly, provided graphical analysis of pay-and-performance based on measures such as revenue and earnings per share growth.

Proxy Access MIA
First, let’s read the gaps. Conspicuous by its absence is proxy access, not available for spring season. The Securities and Exchange Commission had passed rules last year but the U.S. Chamber of Commerce and the Business Roundtable got them stayed legally, arguing that by preempting state law and shareholder rights the rule violates the first amendment to the United States Constitution: “Congress shall make no law respecting or… abridging the freedom of speech.”

Proxy ballots are distributed to shareholders at the H. J. Heinz Co. annual meeting in Pittsburgh. AP photo/Keith Srakocic

The SEC will argue that its proposed rule does not restrict free speech but rather can “enable the federally regulated proxy process to more closely approximate the conditions of the shareholders’ meeting.” An amicus curiae letter from 36 law professors adds that the proposed proxy access rule “neither compels a company to carry speech by third parties nor restricts a company from engaging in speech.” Oral arguments were scheduled to begin April 7, 2011.

Even without direct access, shareholders are making their views on director candidates known. As proxy advisor Patrick McGurn reported in the last issue of NACD Directorship [“Proxy Season Preview: Seven for Yo-Leven,”] the Connecticut Retirement Plans and Trust Funds plan to propose a board diversity resolution and The United Brotherhood of Carpenters and Joiners has launched a letter campaign to get nominating committees to meet with 1 percent holders. McGurn, an executive director at Institutional Shareholder Services (ISS), also predicts that New York City pension funds will be pushing for greater expertise on boards. Companies that listen to such concerns early on will ease their transition into proxy access, should it return from legal exile.

Hot Social Issues
In 2011, one-quarter of the first 359 shareholder resolutions address environmental issues. Forty-one proposals address climate change, most of which request that companies set green house gas reduction goals or adopt public policy principles on climate change issues, including deforestation and renewable energy. Meanwhile, in Congress, 15 current bills address greenhouse gases—including the Defending America’s Affordable Energy and Jobs Act, which has versions in both the House and Senate.

A re-emerging issue has been controversy over the influence and independence of proxy advisors. Almost one year ago, the SEC included this issue in its concept release on the proxy system. NACD joined corporations and shareholders to ask for a closer look at proxy advisor conflicts of interest. Since then, consolidation has increased the clout of the two leaders Glass Lewis (now serving the customers of Proxy Governance) and ISS. Meanwhile, Governance Metrics International (GMI) merged with The Corporate Library, a research organization, increasing its influence in the sphere of governance ratings.

Even without direct proxy access, shareholders are making their views on director candidates known. Companies that listen will ease their transition into proxy access, should it return from legal exile.

Washington will be paying more attention to this issue. The Obama Administration has been relatively active in antitrust (per Global Competition Review, February 2011). Lawmakers in both parties listen to corporate leaders—who continue to be unhappy that some institutional voters follow recommendations from the advisors rather than listening to what companies have to say. Another related and important issue raised by the SEC’s concept release is the fact that many companies cannot reach their shareholders due to the rules that, by default, make brokerage customers objecting beneficial owners (OBO) rather than non-objecting beneficial owners (NOBO). Watch for a revival of this issue.

Say on Pay at Last
Now let’s see what’s right in front of us: say on pay. That’s the big issue this season, thanks to Dodd-Frank. Section 951 of the 2010 law requires public companies holding an annual meeting on or after January 21, 2011, to give shareholders an advisory vote approving the compensation of the company’s top executive officers (including parachutes). The SEC approved final rules January 25 and they are effective now—60 days after publication in the Federal Register. There’s a two-year exemption for “smaller reporting companies” (with revenues and public float of less than $25 million) but the free pass to procrastinate goes only so far. The definition of “smaller reporting companies” under relevant law does not apply to investment companies, asset-backed issuers or corporate subsidiaries (unless the parent is also “small”). According to a new free website, proxymonitor.org, 2010 saw winning votes for say on pay at 14 of the 100 largest public companies in the three proxy seasons leading up to Dodd- Frank (2008-2010)—no doubt encouraging the law and subsequent rules in this regard. Behind the scenes and below the Top 100 ice cap, ISS has identified 220 companies that have revised their pay plans in preparation for this voting season.

A negative recommendation from a proxy advisor can sway up to one in five shareholders, according to the Center for Executive Compensation (CEC) in Washington, D.C., as cited in a February 7 Wall Street Journal article. Since sayon- pay votes became mandatory, ISS has recommended a no vote on 10 percent of the proposals it has reviewed (13 out of 129); Glass Lewis recommended a no vote on 11 percent (18 of 171). In most cases, plans pass despite no votes.

Other Comp Rules on the Way
But say on pay is not the only new issue for 2011. Later this year, the SEC will be issuing final rules on compensation committee and advisor independence (already out in proposed form) and will propose new rules on clawbacks. These parts of Dodd-Frank are considered to be inevitable. Last season’s votes on clawbacks were not lost on legislators. A Master Trust’s clawback resolution at Morgan Stanley last year got 29.84 percent and at Bank of America a clawback proposal got 43.85 percent of the vote. Interestingly, the 2011 policy for ISS says they will proceed “case-by-case” on clawbacks. This may be in part because 73 percent of Fortune 100 companies already have clawback policies—up from 18 percent in 2006, according to the CEC.

Pending Indefinitely
Still up in the air are two other parts of Dodd-Frank: pay for performance and pay ratio. In a recent write-up of regulatory trends, the CEC predicts that House Republicans will push back on both issues, particularly pay ratios. The CEC anticipates that lawmakers may reword these provisions—or possibly ban funding for them. Congress could “prohibit the SEC from using funds to implement the provisions,” notes the CEC in a recent letter to its members.

Pay disparity appears to be a low-priority issue among larger shareholders and therefore could become moot legally. The 2011 ISS Voting Guidelines say: “Generally vote AGAINST proposals calling for an analysis of the pay disparity between corporate executives and other non-executive employees.” But this is a popular issue with members of the Interfaith Center on Corporate Responsibility. According to the Center’s 2011 proxy report, members have filed pay disparity measures at AOL-TimeWarner and General Electric.

Success would be a stretch. Last year, according to proxymonitor.org., the Sisters of Charity of the Blessed Virgin Mary received a 9.82 percent vote on a pay disparity measure at General Electric and The Franciscan Sisters of Perpetual Adoration received a 7.7 percent vote at Allstate—not as low as some have received but hardly a majority.

Policymakers Jaded
If regulators give companies a break from burdensome regulations or go after proxy advisors it will probably be based more on their pro-shareholder sentiment than any compassion for boards or corporate executives. Despite NACD’s many comment letters and meaningful dialogue with key staff on both sides of the aisle, the regulatory mood does not accord boards much importance. Policymakers surveyed in early 2011 for the second annual What Society Thinks? survey, show a jaded view of directors. Recent allegations of illegal insider trading by a prominent director do not help.

The cautious attitude of policymakers may be a hangover from the recent financial crisis. Some policymakers and their staffs are no doubt still reading The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, an unsparing 600-plus pages naming culprits for the financial crisis, including financial company boards.

Interestingly, the 2011 policy for ISS says they will proceed “case-by-case” on clawbacks. This may be in part because 73 percent of Fortune 100 companies already have clawback policies.

Why the tome? Recall that two years ago, with passage of the Fraud Recovery and Enforcement Act of 2009, Congress vowed to study the causes of the financial crisis; this report released in late January, is the result. The Commission was composed of 10 “prominent United States citizens with national recognition and significant depth of experience in such fields as banking, regulation of markets, taxation, finance, economics, consumer protection and housing”—six appointed by the majority leaders of the House and Senate (then Democrats) and four appointed by Republican leaders.

The 2011 report sets the stage by recounting early reforms at Freddie Mac and Fannie Mae and AIG, but similar to the reports surrounding the collapse of Enron, this one goes on to tell of apparently imprudent decisions at a number of financial institutions, including AIG, Bank of America, Bear Stearns, Citigroup, Countrywide, Fannie Mae, Freddie Mac, Lehman Brothers, Merrill Lynch, Moody’s and Wachovia. (The dissenting report written by the four Republican appointees also mentions board decisions but focuses only on failures at the quasi-governmental institutions Fannie Mae and Freddie Mac.)

The main report finds that in institutions extending credit, “lending standards collapsed, and there was a significant failure of accountability and responsibility throughout each level of the lending system. This included borrowers, mortgage brokers, appraisers, originators, securitizers, credit rating agencies and investors, and ranged from corporate boardrooms to individuals.”

With respect to the crisis, it does levy some general blame in the areas of compensation and lending: “Compensation systems—designed in an environment of cheap money, intense competition and light regulation—too often rewarded the quick deal, the short-term gain—without proper consideration of long-term consequences… Often, those systems encouraged the big bet. This was the case up and down the line—from the corporate boardroom to the mortgage broker on the street.”

Dynamic Interplay
The interplay between proxy season and proxy regulation is truly dynamic. Right now, proxy votes are leading and regulations are lagging, but that could switch. All it will take is another crisis. That is why all wise directors and shareholders are looking ahead to prevent one.

Governance Specifics
Say on Pay.
At least once every three years, public companies are required to include in their annual meeting proxy materials a shareholder resolution seeking a nonbinding advisory vote on named executive officer compensation. In addition, at least every six years, the annual meeting proxy materials are required to include a separate resolution seeking a non-binding advisory vote on whether the say-on-pay vote should occur every one, two or three years.

More stories in The Boardroom Guide for New Directors:
Securing Your First Public Company Board Seat: Mission Possible
Directors Registry Now Exceeds 4,000 Listings
A Performance in Three Acts

These requirements took effect during January 2011 for most domestic public companies other than smaller reporting companies; these companies become subject to the rules in 2013.

Michael R. Littenberg

Say on Golden Parachutes.
The proxy statement for a special meeting held in connection with a change in control transaction must seek a non-binding advisory vote on golden parachute arrangements for named executive officers, unless the arrangements previously were voted on by the shareholders at an annual meeting.

The special meeting proxy statement also must include enhanced disclosure of these arrangements, beyond what is required in annual filings that describe executive compensation arrangements. Unlike say on pay, smaller reporting companies do not get a grace period to comply with the say on golden parachute rules.

Proxy Access.
The SEC’s proxy access rules require public companies to include in their annual meeting proxy materials director candidates nominated by shareholders to the extent that the shareholder group has held at least three percent of the company’s voting power for at least three years and is not seeking control. Under the proxy access rules, shareholders can nominate up to 25 percent of the board. Proxy access was scheduled to take effect during November 2010 for most companies and three years later for smaller reporting companies. Within a matter of days after publication of the rules, a petition was filed with the D.C. Circuit seeking judicial review. A decision is expected by the summer.

Compensation Matters
Compensation Committee Independence.
Dodd-Frank requires the SEC to adopt rules directing the national securities exchanges to prohibit the listing of any equity security of a company that does not have an independent compensation committee that meets enhanced independence standards. In determining independence of a committee member, the exchanges will be required to consider other compensation paid to the member, including any consulting, advisory or other compensatory fee, and whether the member is affiliated with the company, one of its subsidiaries or an affiliate of a subsidiary.

Independence of Compensation Advisors.
When a compensation committee hires a compensation consultant, legal counsel or other advisor, it will be required to first consider certain independence factors, including the provision of other services to the company by the advisory firm, the amount of fees received from the company by the advisory firm as a percentage of that firm’s total revenue, the policies and procedures of the advisory firm designed to prevent conflicts of interest, any business or personal relationship between the advisor and members of the compensation committee and any stock of the company owned by the advisor.

The compensation committee still will retain discretion whether to obtain outside advice. And, although the committee will be responsible for the appointment, compensation and oversight of the advisor’s work, it will not be required to implement or act consistently with the advice or recommendations of the advisor. The SEC has indicated it intends to adopt rules giving effect to committee and advisor independence before August 2011. The rules generally will not apply to controlled companies and the SEC has discretion to exempt smaller public companies.

Enhanced Executive Compensation Disclosure.
The SEC is required to adopt rules mandating companies to disclose “pay versus performance” in the annual meeting proxy statement. Companies will be required to disclose information that shows the relationship between executive compensation paid and the company’s financial performance.

Dodd-Frank also requires the SEC to amend its executive compensation disclosure requirements to require companies to disclose the median annual total compensation of all employees excluding the CEO, annual total compensation of the CEO and the ratio of the former to the latter. Rules relating to these portions of Dodd-Frank are expected to be adopted before the end of 2011.

Compensation Clawbacks.
The national securities exchanges will be required to enhance their listing standards to require companies to adopt more expansive clawback policies. Under the new standards, if a listed company is required to prepare an accounting restatement due to material non-compliance with financial reporting requirements, it will be required to recover from any current or former executive officer who received incentive-based compensation based on the erroneous data during the preceding three-year period, the amount that is in excess of what would have been paid under the restated financial information. Expanded clawback rules are expected to be adopted by the SEC before the end of 2011.

Disclosure of Hedging Policies.
Companies will be required to disclose in their annual meeting proxy statements whether any of their employees or directors or their designees are permitted to purchase financial instruments (including equity swaps and collars) designed to hedge or offset a decrease in the market value of equity securities granted to the employees or directors as part of their compensation or held directly or indirectly by them. These disclosure requirements are expected to be adopted before the end of 2011.

Michael R. Littenberg is a partner in the New York office of Schulte Roth & Zabel LLP. He can be reached at michael.littenberg@srz.com.

The study—which looked at 170 Fortune 1000 companies whose annual meetings were on or after January 21, filed proxies by late March 2011 and whose CEOs were in their role for the last three years—found that 74.7 percent of the companies’ say-on-pay proposals were supported by at least 90 percent of voters. Only 2.7 percent of the companies had did not have majority support on their proposals.

“One of the most common questions we were being asked was: would proxy advisors like Institutional Shareholder Services be influential on these new votes?” said James Kroll, a senior consultant in Towers Watson’s Executive Compensation Practice, in reference to the say-on-pay and say-on-frequency votes that many companies are facing for the first time this proxy season.

While most companies’ investors approved say-on-pay practices, the 14 percent of companies who received negative ISS recommendations received above-average shareholder opposition. At companies where ISS encouraged a “for” vote, 94 percent also voted “for.” But the 20 companies surveyed who ISS recommended a “no” vote on their say-on-pay provisions received on average 71 percent positive votes; four were rejected by shareholders.

Annual say-on-pay votes have been popular among shareholders so far this proxy season, with annual votes receiving majority support at three quarters of the companies surveyed. Of the companies that recommended triennial votes, a majority of shareholders agreed to only a third.

Doug Friske

Of the decisions made so far, 46 companies chose annual, one chose biennial and 14 chose triennial say-on-pay votes.

“In early January and February, most proxies recommended triennial votes, now most are recommending annual,” continued Kroll. “Companies may be seeing the majority support for annual [votes] from shareholders, which may be driving more businesses to make the annual vote recommendation.”

The study also reported that the median annual base salary for executives increased by three percent. “The pay mix has stayed the same,” explained Olivia Wakefield Lee, a senior consultant at Towers Watson’s Executive Compensation practice. “What has changed is the long- term incentive mix,” with companies using stock options for 33 percent of the mix, as opposed to 39 percent in 2008. Restricted stock has stayed relatively constant, while performance plans make up a higher percentage at 41 this year, over 37 and 36 in 2008 and 2009, respectively.

“Options are not on the verge of extinction, but they will decrease in percentage of the mix,” predicted Wakefield.

Compensation committees and consultants were recently handed new regulations stemming from the Dodd-Frank Act regarding their independence and possible conflicts of interest. Steve Seelig, executive compensation counsel for Towers Watson’s Research and Information Center, advised companies to be on the lookout for more regulations. “We don’t anticipate things to be too tumultuous when it comes to regulations from Washington,” he said, but “there are some regulations pending, and it’s not too early for companies to focus on complying with them, since the rules are somewhat cumbersome.”

While there is currently legislation in the House to repeal the mandated disclosure of CEO pay vs. median employee pay, Seelig said: “I don’t see it going through the Senate or being approved by the President.”

Considering the combination of these types of increased disclosures and shareholder say on pay, companies must be especially cognizant of how they present their compensation practices in their proxies.

There is no formulaic method to encourage shareholders to approve say-on-pay plans, Seelig said. Rather, companies must look at their own shareholders and determine what their concerns are, and what the proxy advisors that most shareholders listen to are recommending.

“The results will change every year,” Seelig explained. “Stay committed to your principals and practices; shareholders will support your approach if they see it’s been thought through.”

While I had planned on a football theme with eleven players on either (take your pick) the U.S. gridiron or the rest-of-the-world’s pitch, the governance guru/gambler’s remark required research. After a Google and a few Wikis, I learned that initial rolls of the dice that add up to either seven or eleven are “natural” winners at the craps table. Eleven is called out at the table as “yo-leven” (or “yo”) due to the potential for confusion given the similar sound of seven.

As I pictured the bevy of boardroom requirements tumbling out of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), it hit me that a roll of the dice would more than suffice as the 2011 season’s symbol. While directors will not imagine that they are in the Nevada desert once the say-on-pay tsunami makes landfall, they may feel like riverboat gamblers—slightly queasy and desperately seeking terra firma. The deal-sealer was an obscure Wiki factoid: craps devolved from an old English dice game called “hazard.”

So without further ado, here is a list of seven potentially hazardous points that directors should prepare to roll when they step up to the boardroom craps table for the yo-leven proxy season.

Democrats’ Snake Eyes Roll May Roil Directors
The 2010 annual meeting season was quiet thanks to all of the noisemaking in the nation’s capital. In the wake of the Wall Street-driven market meltdown, all eyes locked onto K Street and Capitol Hill. Many activists actually down shifted their 2010 annual meeting efforts in favor of a march on Washington D.C.

This capital investment paid dividends as Dodd-Frank looked like it would tip the governance table in activists’ direction for 2011 and beyond. Reformers were on a hot steak last summer as Congressional stick men Senator Chris Dodd and Representative Barney Frank passed loaded dice over to the Securities and Exchange Commission (SEC). With the long-coveted cover of Congressional authorization, the Commission adopted its proxy access rules in August 2010 and began implementing Dodd-Frank’s say-on-pay mandates.

Before the winning chips were pushed across the table, however, the U.S. Chamber of Commerce and the Business Roundtable asked the U.S. Court of Appeals for the D.C. Circuit to invalidate the SEC’s access rule. In October 2010, the Commission shocked the good-governance crowd by staying the effectiveness of the rules pending resolution of the legal challenge.

Next, in early November 2010, Washington’s reign as the epicenter of the governance universe abruptly ended when Congressional Democrats rolled snake eyes in the mid-term elections. The subsequent musical chairmen game led to an ideological sea change in the U.S. House of Representatives as Alabama Republican Spencer Bachus replaced Massachusetts Democrat Barney Frank as chair of the House Financial Services Committee. Rep. Bachus promised to go title-by-title through his predecessor’s namesake Act to “correct, replace or repeal the job killing provisions that unnecessarily punish small business and community banks that did nothing to cause the financial crisis.”

The odds of Dodd-Frank’s repeal are low since Democrats still control both the U.S. Senate and the White House. Undaunted, newly installed Republican committee chairs have already begun to harass agency rule writers—via tough oversight—and to starve—via slow, low or zero appropriations—the SEC and the various new bureaucracies envisioned by Dodd-Frank.

Without the promise of further governance changes via Federal fiat and with proxy access offline, directors should prepare for bumper crops of shareholder proposals, letter-writing campaigns, “just vote ‘no’” efforts and old-school proxy fights this year. Notably, activists have turned their attention to the leftovers—especially majority threshold voting (MTV) in uncontested elections—from last year’s Congressional chow down at the governance buffet.

Boards Weigh Odds of Activists Rolling Hard Six
As a result of the SEC’s stay, the Commission’s rule (14a-11), which would have become effective on Nov. 15, 2010, sits in limbo. Even assuming the Federal courts uphold the rule, implementation will not come in time to impact the 2011 proxy campaign. The SEC stay also delays amendments to Rule 14a-8 that would have allowed investors to file bylaw proposals creating more permissive access procedures.

While 14a-11 nominees and 14a-8 bylaws will not appear on 2011 ballots, some activists have begun to build the infrastructure that will allow them to exploit access once it is up and running. The rule, if implemented, will require wannabe shareholder nominators to roll six the hard way—owning at least three percent of a public company’s voting stock for at least three years. That means only big players need apply. Some mega-money managers tell us that they have already received feelers from activists who seek to gauge their future interest in joining coalitions to clear the three-percent/three-year hurdle.

Two of the market’s highest rollers, the $220 billion California Public Employees Retirement System (CalPERS) and the $140 billion California State Teachers’ Retirement System (CalSTRS), are rounding up possible candidates for boards. The two fund giants partnered in 2010 to develop a database of potential shareholder-friendly director candidates with diverse talents. This “Diverse Director Database,” or 3D, opened last year and the funds are fielding resumes.

These first 30 companies range from $5 billion to $125 billion in revenue and span a variety of industries.

Author Yonat Assayag

New federal regulations under the Dodd-Frank Act require companies to hold non-binding shareholder votes on their executive pay programs (say on pay), the frequency of future say-on-pay votes (say on frequency), and golden parachute payments in the event of a transaction (say-on-golden parachutes). The say-on-pay and say-on-frequency votes are required for all publicly-traded companies with annual shareholder meetings held after January 21, 2011. The say-on-golden-parachutes requirement is effective April 4, 2011. Smaller reporting companies (less than $75 million in public float) are granted a two-year delay until these votes are effective.

As boards consider implications of these advisory votes, they no doubt are wondering what other companies are doing in light of say on pay. Are companies “staying the course” and letting the chips fall as they may, or are they proactively modifying their executive pay programs and/or disclosure in an attempt to secure majority support from shareholders?

Program Changes

Author Russ Miller

In 2010, companies sought to minimize shareholder distractions and improve the pay/performance relationship and shareholder alignment:

• Ashland Inc., Johnson Controls and six other companies eliminated excise tax gross-ups
• Of 20 companies disclosing clawback provisions for their named executive officers, 10 adopted these provisions recently. For example, Franklin Resources and Visa implemented clawback provisions in 2010
• While CEO stock ownership guidelines of 5x salary is most common among Fortune 500 companies, two companies (Qualcomm and Agilent Technologies) increased their guidelines from 5x to 6x salary, possibly in response to Institutional Shareholder Services’ (ISS) preference
• 18 companies disclosed an anti-hedging policy prohibiting executives from using hedging vehicles against the company’s stock, compared to 11 companies in 2009

Disclosure Changes
There was a noticeable shift in the approach to the Compensation Discussion & Analysis (CD&A) section of the proxy statement among the First 30. CD&As are being treated less as a compliance exercise and more as a tool for effectively communicating with shareholders about the decisions and rationale behind the executive pay program. CD&As among the First 30 made information more accessible to the reader:

• Prevalence of executive summaries more than doubled, from nine companies last year to 20 companies this year. Executive summaries highlighted company performance, pay-and-performance alignment, and any key changes to the compensation program
• Companies used more charts and graphs to describe their pay programs and illustrate pay-performance relationships in a user-friendly way. Deere & Co., for example, included a chart in its proxy statement plotting the CEO’s and other named executive officers’ three-year total “realizable” compensation relative to peers vs. relative total shareholder return over the same three-year period.
• In addition, all of the First 30 companies discussed pay versus performance in some way in their CD&A and nine disclosed the information graphically. This level of disclosure may be a preview to the pending pay/performance disclosure requirement under Dodd-Frank, which won’t likely be be effective until 2012.

Say-on-Pay and Say-on-Frequency Resolutions
Given that the SEC did not specify a form of resolution for the shareholder votes, companies took a wide range of approaches in preparing their resolutions. Say-on-pay resolutions ranged from a brief description of the vote with reference to the CD&A (an approach taken by Hewlett Packard, Starbucks and Walt Disney) to a multi-page analysis of the objectives of the compensation program, the pay-for-performance relationship and key features. The most common approach (18 companies) was somewhere between these two extremes, where the company provided a one-page supporting statement reminding shareholders of the key elements of the program (similar to an executive summary).

A group calling itself Tea Party Patriots gathers for a “Reclaiming the Capitol” rally in Washington, D.C., on election day.

Yes, this “A factor” makes one’s head spin, but so does Washington. In following the changing moods of the Capital City, directors got used to self-governance in response to market signals (remember all those voluntary governance guidelines?), then mandated conformity to myriad rules and now a possible return to less government. The U.S. Chamber of Commerce succeeded in halting proxy access through court action and we are hearing vows to overturn many of the new laws. While most of these pledges pertain to broad national laws, such as healthcare reform (aka “Obamacare”), some pertain to governance changes.

Here’s a look at the state of the A-factor from the executive, legislative and judicial branches of our ever-changing government.

Executive Branch
The Securities and Exchange Commission is forging full speed ahead as it implements Dodd-Frank. The SEC’s 2011 to-do list includes finalizing rules on “say on pay” and whistleblowing, and proposing new rules on compensation committee and advisor independence, executive pay clawbacks, uninstructed broker votes on “other issues,” hedging by employees and directors, pay for performance and (perhaps extending into 2012) pay ratios of CEOs to workers. As the year starts, the SEC staff is reviewing more than 1,000 comment letters it has received on its proposed whistleblowing rule, including NACD’s. The antiwhistle backlash may cause the SEC’s rule to limit the scope of the rule significantly, or face a technical correction to this part of the Dodd-Frank law, courtesy of the new Republican majority.

In coming years, the A-factor may cause reallocation of SEC funds from punishment to education—possibly changing the director’s job from scapegoat to communicator. Currently, more than half of the SEC’s operating budget is devoted to enforcement rather than prevention. In a recent lecture at the American Enterprise Institute (AEI), attorney Peter J. Wallison took issue with this allocation. “If… the SEC [were] more interested in giving advice and solving problems rather than collecting scalps there might be more candor and voluntary disclosure. But when the SEC only seems interested in bringing enforcement actions it’s inevitable that bad conduct will be hidden until the scheme simply collapses of its own weight.” The AEI lecture series is named after the late A. A. Sommer Jr., a former SEC commissioner who served on the board of NACD during its formative years, and in 1999 chaired the first NACD Blue Ribbon Commission on the Audit Committee. Sommer’s moderate positions on the issues of his time have had a lasting impact on governance and the culture of NACD.

The Federal Bureau of Investigation could come knocking on more boardroom doors, alleging that a particular business practice engaged in was “criminal” and will merit jail time. According to the FBI, white-collar crimes are categorized by “deceit, concealment or violation of trust” and are not dependent on the application or threat of physical force or violence. Such acts are committed by individuals and organizations “to obtain money, property, or services; to avoid the payment or loss of money or services; or to secure a personal or business advantage.”

Among other business practices, the FBI investigates allegations of securities and commodities fraud, fraud against the government, copyright violations and telemarketing, healthcare and bank fraud. In healthcare, the FBI says it targets systemic abuses, such as large-scale billing fraud. In banking, the FBI pursues financial institution fraud involving $100,000 or more.

Could officers and directors be implicated in criminal investigations even if they had no criminal intent? Over time, the definition of crime has expanded to include a wide range of behaviors, to the point where mere noncompliance may be criminalized.

More facts: The number of agents investigating “corporate and other securities, commodities, and investment fraud cases” has increased 47 percent, from 177 in 2001 to more than 250 today, according to the enforcement agency. Since 2007, there have been more than 1,700 corporate, securities, commodities, and investment fraud cases, an increase of 37 percent since 2001. FBI special agents work with investigators from the SEC and other government agencies, including the Treasury’s Financial Crimes Enforcement Network, targeting what it calls “sophisticated, multi-layered fraud cases that harm the marketplace and threaten our economy.” It’s enough to keep audit committee members up at night.

Legislative Branch
The House Committee on Ways and Means is likely to lower the tax rate—but investors may still panic at the high rates they now face. While the top statutory capital gains rate in 2011 is 20 percent, the top effective rate will actually be 22 percent. For dividends, while the top statutory rate will be 39.6 percent in 2011, the top effective rate will actually be 41.6 percent. But because of the additional, hidden tax rate increases (buried in the new health law) the top effective rate on capital gains and dividends in 2013 will be 25.8 percent and 45.4 percent, respectively.

The nearly 50-percent levy on investors’ dividend income may put more pressure on investors to achieve short-term returns through their portfolios. Boards need to put shareholder relations (and corporate pension-fund management) high on their list of agenda items.

Meanwhile, the Internal Revenue Service will be requiring companies to report “uncertain tax positions” on their tax returns. The time is now for audit committees— and perhaps boards—to inquire about this issue.

Judicial Branch
The Supreme Court has decided or heard three cases on arbitration in recent months. The topic is of natural interest to boards, since corporate directors are likely to experience a conflict at some point in their years of service and arbitration outcomes can be more moderate than court outcomes.

In a ruling in April in Stolt-Nielsen S.A. v. Animal Feeds Int’l Corp., the Supreme Court said that if an arbitration agreement is silent on the subject of class action, such an action cannot be imposed on parties to the agreement. Imposing class arbitration on parties who have not agreed to authorize such arbitration, the Court said, is inconsistent with the Federal Arbitration Act. In the pending case of Rent-A-Center, West Inc. v. Jackson, the question is who gets to determine claims of unconscionability— the court or an arbitrator. AT&T Mobility v. Concepcion, also still pending, concerns whether the Federal Arbitration Act preempts states from conditioning the enforcement of an arbitration agreement on the availability of particular procedures. If you have any existing arbitration agreements or plan to sign any, ask counsel to help. In these changing times, it’s more important than ever to stay current.

To read NACD comment letters on the proxy system, proxy access, shareholder votes on executive compensation and golden parachutes, and most recently, whistleblowing, visit sec.gov or email a request to resources@ nacdonline.org.

Stephen L. Brown

What do you like most about the changing boardroom landscape?
The passage of the corporate governance reforms included within Dodd-Frank was a watershed event that affects boards, management and shareholders alike. Boards and management will now have to take more interest in investors’ viewpoints. And shareholders must take on greater responsibility in monitoring boards with the tools provided to them by Congress.

Are the new requirements being embraced or resisted?
Both. The best practitioners—issuers who have always addressed governance into their road shows, for example—are continuing to do the right thing, and I don’t think Dodd-Frank has raised their blood pressure much. You have another category of issuers who are new to engaging with shareholders and they’ve embraced the challenge and are sincerely attempting to understand how to be more responsive to shareholders. And then there is this third category of what I like to call “the governance cavemen and cavewomen.” These are folks who are still in the Stone Age about the need for regular dialogue with their key shareholders.

Why did it come to the necessity of enacting a law?
Many would have preferred private ordering to achieve reform. However, when market participants can’t find consensus, regulation follows. With respect to say on pay, a few years ago we approached some of our largest portfolio holdings and asked them to voluntarily adopt an advisory vote with hopes that the rest of the market would follow. Many responded that they preferred to wait for legislation; not wanting to be a first mover. The lack of widespread voluntary adoption mixed with public angst over executive compensation, and the onset of a financial crisis, yielded an inevitable response by public policymakers. So, here we are.

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More stories in the Director’s Guide to Compensation:
New Risks and Rewards
Executive Pay and the Boardroom After Dodd-Frank
New Rules Give Power To The Compensation Committee

Do governance practices differ among companies according to market capitalization?
The fact is that over the last decade the larger-cap companies have been the focus of large institutional investor activism; so those companies have responded to the various viewpoints of shareholders with respect to governance best practices. However, most of the mid- and small-cap companies have had the cover of the large caps. It’s likely to be different now. No more cover. The mid and small caps will have to raise their governance IQs and address governance more proactively.

How often do problems in corporate governance relate to CEO compensation?
It’s often a red flag rather than a cause. We define problems not by the absolute amount of compensation, but focus on whether or not the compensation program is aligned with our interest in creating long-term sustainable shareholder value. Compensation issues can be indicative of misaligned risk/reward incentives, lack of long-term focus, or simply show that there’s not enough counter balance in the boardroom.

Directors could take the outcome of a say-on-pay vote and bring it in with them to a meeting with the CEO saying, “Listen, this is what shareholders are thinking.”

You might have read that Rob Feckner [president of the California Public Employees Retirement System] said CalPERS would no longer publish its watch list and that they would approach companies privately because they thought it would be more effective. Do you agree with this kinder, gentler activism?
We absolutely agree that it’s more effective. Quiet diplomacy has always been TIAA-CREF’s style of issuer engagement. In our experience, you can achieve optimal outcomes when you can get a company to focus solely on key governance issues and avoid public embarrassment over being targeted. A sense of partnership and respect are elements that should exist when engaging with issuers to bring about changes aimed at long-term value creation. More aggressive approaches may be warranted at times, but it is certainly not the starting point for long-term focused institutional shareholders.

What are the means or methods that you’ve seen in which directors are effectively communicating with TIAA-CREF?
We appreciate clear and meaningful proxy disclosures. Disclosure should not simply be viewed as regulatory mandates, but rather as an opportunity for directors and management to make their case to shareholders. TIAA-CREF takes care to intelligently execute our proxy-voting duties and we can do so effectively and efficiently when we are able to understand with confidence how directors exercised their duties on our behalf. Providing clear, concise and meaningful disclosure in the [Compensation Disclosure & Analysis] section of the proxy is one such opportunity with respect to compensation. The newly required enhanced disclosure related to board leadership, director qualifications, risk oversight and other related corporate governance issues is another opportunity to tell your story. The arrival of mandatory say-on-pay votes this proxy season heightens the importance of providing good disclosure.

Direct dialogues should complement good disclosure. While we do speak with companies during proxy season, the most constructive dialogues occur at governance “road shows” outside of proxy season when there is more time.

How can a company prepare for a governance road show?
It’s common for issuers to create an agenda with us prior to the meeting. That way both sides can manage expectations and ensure that the issuer has the right people in the room. The right people include those senior executives who can speak knowledgeably about issues on the agenda—we are starting to see more heads of executive compensation in these meetings in order to address detailed compensation questions. Although we know it is not always feasible all the time, having independent directors as part of these meetings is an invaluable emerging best practice. Finally, prior to embarking on a road show, it can be helpful for issuers to host their own mock dialogue with their outside advisors such as compensation consultants.

That’s an excellent idea. Tell me, what do you think of say on pay?
We think a shareholder vote on executive compensation policies empowers both investors and boards. It allows board members to use investor sentiment as expressed through its advisory votes in their conversations with the C-suite. It arms the compensation committee chairs with real feedback. Directors could take the outcome of a say-on-pay vote and bring it in with them to a meeting with the CEO saying, “Listen, this is what shareholders are thinking.” And by the way, these shareholders have the power to vote directors off the compensation committee and out of office, particularly if directors are elected by a majority of votes in uncontested elections.

Are there areas of frustration for you that were not addressed in Dodd-Frank?
I think many people are unhappy that majority voting was taken out of the corporate governance provisions of Dodd-Frank. But the vast majority of your large-cap companies have already adopted this best practice. And the rest of the issuers who have yet to adopt will likely see significant shareholder pressure to do so this year.

Author Blake Hornick

“Say on pay” votes
A public company will be required to have its first say on pay vote at its first annual meeting taking place on or after January 21, 2011, the six-month anniversary of the effective date of the Dodd-Frank Act. Thereafter, a company must seek a say on pay vote at least once every one, two or three years as presumably determined by a separate shareholder advisory vote. The new rules include say on pay votes in the list of items that do not require the filing of preliminary proxy materials with the Commission.

The new say on pay rules require a non-binding advisory vote with respect to all compensation of a company’s NEOs under Item 402 of Regulation S-K, which includes a company’s compensation policies and procedures with respect to NEOs described in the Compensation Discussion & Analysis (the “CD&A”) as well as the tabular and narrative disclosure of compensation, contractual rights and severance benefits of NEOs elsewhere in the proxy. The new rules require the proxy to include disclosure explaining the vote is being sought pursuant to provisions of the Dodd-Frank Act, its general effect and that it is non-binding. In addition, the new rules require a company, commencing in 2012, to update its CD&A to address whether and, if so, how its compensation policies and procedures take into account the results of say on pay votes.

Author Michael Dunn

The new rules do not require the specific use of any specific language or form of shareholders’ resolution, however the SEC has added a general instruction to the final rules which provides non-exclusive, sample disclosure that will be deemed to comply with the new rules.  The rules permit a company to seek a single advisory vote on all compensation of all of its NEOs as a group. A company also may elect to seek separate votes with respect to separate elements of compensation for all of the NEOs, such as separate votes for base salary, bonus, and equity compensation awards, or for individual NEOs, but we do not expect most companies to elect either of these options.

The new rules also provide that these matters are ones as to which brokers are prohibited from exercising discretionary voting without instructions from the beneficial owner pursuant to Section 957 of the Dodd-Frank Act.

Frequency votes
In addition to the first say on pay vote that occurs at a public company’s first annual meeting taking place on or after January 21, 2011, a company also must seek a separate shareholder advisory vote on whether the say on pay vote should be held every one, two or three years. A company must seek this frequency vote at least once every six years.  In addition, the final rules also require annual proxy disclosure of the current frequency of a company’s say on pay votes and when the next say on pay vote will occur.

As is the case with say on pay votes, the new rules require the proxy to include disclosure explaining the vote is being sought pursuant to provisions of the Dodd-Frank Act, its general effect and that it is non-binding. The filing of preliminary proxy materials is not required for these votes.

The new rules require that proxy cards give shareholders four options with respect to a frequency vote: one, two or three years or to abstain from voting.

A board of directors may, but is not required to, include its recommendation. The proxy disclosure, however, must clearly state that shareholders have four choices and are not voting to approve or disapprove the board’s recommendation. The final rules provide that if a company provides a recommendation with respect to the frequency vote and provides for all four voting options on the proxy card, then management may vote signed but uninstructed proxy cards in accordance with the company’s recommendation for the frequency vote so long as the proxy card includes prominent, boldface language in accordance with current rules stating how uninstructed shares will be voted.

In addition, because the frequency vote is advisory, the new rules do not mandate a standard for determining which frequency is deemed to have been recommended by shareholders. However, if a company has adopted a policy on the frequency of say on pay votes that is consistent with the choice selected by the majority of votes cast in the most recent frequency vote, then the new rules would permit a company to exclude from its proxy materials subsequent shareholder proposals recommending a frequency standard inconsistent with that elected by a majority of its shareholders.  It is noteworthy that the original exclusionary threshold that was proposed by the Commission was a plurality standard and not the majority standard adopted in the final rules.  The final rules further expand the scope of the proposed rules to also permit a company to exclude from its proxy materials subsequent shareholder proposals relating to executive compensation advisory votes within substantially the same scope as the new say on pay rules if the company has adopted a policy on the frequency of say on pay votes that is consistent with the choice selected by the majority of votes cast in the most recent frequency vote.  Abstentions would be disregarded in this context.

The new rules require a company to disclose under expanded Item 5.07 of Form 8-K the results of its say on pay and frequency votes together with the results of all other voting results from the meeting within four business days of the meeting.   In addition, the final rules require a company to amend this Form 8-K to disclose its decisions regarding how frequently it will hold say on pay votes in light of the voting results from the meeting.  The amendment to the Form 8-K will be due no later than 150 calendar days after the meeting, but in no event later than 60 calendar days prior to the deadline for the submission of shareholder proposals under Rule 14a-8 for the subsequent annual meeting.

Golden parachutes
The new rules create a new paragraph (t) of Item 402 of Regulation S-K that requires enhanced disclosure relating to all golden parachute compensation arrangements in connection with certain transactions relating to an acquisition, merger, consolidation, proposed sale, or disposition of all or substantially all of a company’s assets. The disclosure is required in proxy statements seeking approval of the issuance of shares in a merger proxy and Schedule 14D-9 solicitation/recommendation statements to ensure that the disclosure is required regardless of the form of the transaction. However, the SEC determined not to adopt the proposed rules that also would have required Item 402(t) disclosure in Schedule TO filings by third party bidders, so long as the transaction is not a going private transaction subject to Rule 13e-13.  The new rules require a target company to disclose all written or unwritten agreements that it has with its NEOs or the NEOs of the acquiring company with respect to compensation that is based on or otherwise relates to such transaction. In addition, if the acquiring company is making the solicitation, then it must provide the same disclosure with respect to any agreements or understandings with its NEOs or the NEOs of the target.

The new rules mandate tabular disclosure of the compensation arrangements covered by the new rules that is somewhat different from (and is more extensive than) the narrative disclosure of change-in-control and post-termination arrangements currently required under paragraph (j) Item 402 of Regulation S-K. The new tabular disclosure must quantify for each NEO:

• cash severance payments;
• accelerated stock awards, accelerated vesting option awards, and payments made in cancellation of stock and option awards;
• pension and nonqualified deferred compensation benefit enhancements;
• perquisites;
• tax gross-ups;
• any other benefits; and
• the aggregate of all such compensation.

The final rules clarify that disclosure of amounts that would not be paid or payable in connection with the transaction subject to shareholder approval is not required. The final rules also permit a company to insert additional columns or rows in the table to provide additional information that the company believes is meaningful for investors.

The new rules require footnote disclosure of which amounts in the table are triggered by the transaction (i.e., single trigger) and which amounts are contingent upon additional conditions, such as termination of employment (i.e., double trigger). The rules do not require disclosure or quantification of amounts of previously vested awards, compensation from bona fide post-transaction employment agreements executed in connection with the merger or acquisition transaction, or compensation disclosed in the Pension Benefits Table and Nonqualified Deferred Compensation tables.

The new rules also require additional narrative disclosure of:

• any material conditions or obligations applicable to the receipt of payment (including non-compete and non-solicitation agreements, their duration, and provisions regarding waiver or breach);
• a description of the specific circumstances that would trigger payment (whether lump sum or annual, their duration, and who would provide the payments);and
• any material factors regarding each agreement.

Under the new rules, as noted above, any proxy or information statement relating to an acquisition, merger, consolidation, proposed sale, or disposition of all or substantially all of a company’s assets must include a separate shareholder advisory vote on these compensation arrangements unless all of the transaction-related compensation agreements and understandings were the subject of a prior say on pay vote. As noted, a say on pay vote that includes only the narrative disclosure of change-in-control and post-termination arrangements currently required under paragraph (j) Item 402 of Regulation S-K would not be sufficient for this purpose. We believe that most companies will not elect to comply with the new disclosure referred to here in their annual proxy statements and to include them only if and when there is a merger or similar transaction.

Blake Hornick is a partner and Michael Dunn is a senior associate in the New York office of Seyfarth Shaw. This article was adapted from a recent Seyfarth Shaw client alert.