Compliance Bulletin

Dodd-Frank: Executive Compensation and Corporate Governance
November 29, 2010

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Act”) includes a number of provisions affecting the governance of public companies and their compensation of senior officers and directors. Many of the provisions are amendments to the Securities Exchange Act of 1934 and are statutory codifications or modifications of existing rules and guidelines.

 Generally the provisions discussed in this Bulletin become effective after rulemaking by the Securities and Exchange Commission, the securities exchanges or, in the instance of compensation practices of “covered financial institution,” the federal banking agencies.


“Say on Pay” and “Golden Parachute”

Beginning with its annual shareholder meeting occurring on or after January 21, 2011, a public company must give shareholders an opportunity for a non-binding vote whether to “approve” the compensation of the company’s executive officers as disclosed in the annual proxy statement. The vote must be taken at least once every three years. In addition, at least once every six years beginning with the first say-on-pay vote, shareholders must separately determine whether such vote is to be taken every one, two or three years.

Shareholders have an additional non-binding vote on the compensation of named executives (“golden parachute” vote) when approving certain mergers, acquisitions or dispositions involving all or substantially all of the company’s shares. The compensation arrangements are required to be disclosed in the proxy statement or other materials, in particular how the compensation to be paid or become payable “is based on or otherwise relates to” the transaction. The shareholder vote on compensation must be separate from the vote on the transaction. The SEC has issued proposed rules on these provisions, and they are to become effective in early 2011.

The non-binding say-on-pay and golden parachute votes may not be construed to overrule a company or board decision, affect the company’s or board’s fiduciary duties, or affect the ability of shareholders to make any other proposals for inclusion in proxy materials related to executive compensation. The SEC may exempt an issuer or class of issuers from these votes, and in doing so is required to take into account any disproportionate burdens placed on smaller issuers.

Compensation Committee Independence

The compensation committees of public companies must be composed exclusively of persons who are “independent” and members of the board of directors. In defining the meaning of the term “independent,” the SEC, no later than July 2011, must require the securities exchanges to consider the source of the committee member’s compensation, particularly whether the member receives consulting and other fees from the company, and whether the member is an affiliate of the company or its subsidiaries. Here too, the SEC has the authority to establish exemptions for certain kinds of committee member/company relationships in consideration of a company’s size and other factors.

Independence of Compensation Consultants and Advisers

If the compensation committee uses consultants, legal counsel and other advisers (collectively, “consultants”) in carrying out its duties, it must also consider whether the consultants are independent. The SEC will identify by rulemaking the factors that affect the independence of retained consultants. The factors are to be “competitively neutral” and will include the extent that the consultant’s firm provides other services to the company, the amount of fees received by the consultant’s firm from the company as a percentage of the (consultant’s) firm’s total revenue, the consultant firm’s conflict of interest policies and procedures, any business or personal relationship between the consultant and a member of the committee, and any company stock owned by the consultant.

These restrictions do not diminish the compensation committee’s own independence, as the Act affirms that the committee may, in its sole authority, decide to engage and oversee its own consultants. The compensation committee also retains the responsibility to exercise its own judgment, and is not bound to follow the advice of its consultants. Companies are required to disclose in their annual proxy statements whether the compensation committee has retained a compensation consultant, the existence of concerns over consultant conflicts of interest and, if any exists, how those concerns have been addressed. Also, the company is required to furnish the committee with adequate resources for the committee to pay for consultants. The SEC has the authority to establish exemptions from the consultant independence rules. A “controlled company” is statutorily exempted, which is a listed company in which in a board election more than 50% of its shares are held by one individual, group, or another issuer.

Disclosure of Compensation vs. Performance

The SEC is required to establish rules for the disclosure of executive compensation in relation to the company’s financial performance, inclusive of stock price movement and dividends. Additionally, the CEO’s total annual compensation must be disclosed in comparison with the median annual compensation of all employees not including the CEO. As can be imagined, how to calculate the value of compensation for the purpose of this disclosure could be difficult. The SEC will issue a rule setting forth the details.


The Act provides that the SEC must issue rules directing the securities exchanges to prohibit the listing of companies that do not comply with certain clawback provisions triggered by restatements. Companies will be required to adopt policies to recover incentive compensation, including stock options, paid to executive officers (not just the CEO and CFO) based on financial information that the company later is required to restate because of non-compliance with reporting requirements. The clawback amount is the excess of what the executive would have been paid under the restated accounting. The clawback period is the three years before the date of the restatement.

Disclosure of Hedging Policies

The SEC will issue rules requiring companies to disclose in any annual proxy or material soliciting shareholder consent whether any employee or director or a designee is permitted to purchase instruments (such as forward contracts, equity swaps, collars, and exchange funds) designed to hedge against any decrease in the value of equity stocks given as compensation to, or held by, the employee or director.

Excessive Compensation/Risk-Taking

Earlier this year the federal banking agencies issued joint guidance on the payment of incentive compensation to any bank employees. The Act directs federal regulators, including the banking agencies, to issue regulations or guidelines to require each “covered financial institution” to disclose to its regulator its incentive compensation arrangements as necessary to determine whether such arrangements, including fees and benefits, are “excessive” or could lead to material financial loss to the institution. Disclosure of the amount of compensation paid to any particular individual is not required. Separately, the agencies are required to issue another regulation prohibiting incentive compensation plans that are excessive and that encourage inappropriate risk taking. A “covered financial institution” includes banks and bank holding companies, broker-dealers, credit unions, Fannie and Freddie, and any other financial institution that the agencies may determine by rule, except that institutions with less than $1 billion in assets are exempted.


Broker Voting

The Act requires the national securities exchanges to prohibit any member that is not the beneficial owner of a security from granting a proxy without instructions from the beneficial owner. This restriction pertains to votes on the election of directors, executive compensation, and any other significant matter, as determined by the SEC. However, a broker is permitted to vote shares if the broker received voting instructions from the beneficial owner.

Proxy Access

The Act authorizes the SEC to issue rules allowing shareholders to nominate candidates for directors. The SEC issued a controversial rule earlier this year that, among other things, limits this right to shareholders that have owned at least 3% of outstanding shares for at least three years. Those rules are stayed as a result of a legal challenge. To review the rule, go to the SEC’s website by clicking on this link:

Chairman and CEO

The question of separating the roles of Chairman and CEO was addressed in the Act. The SEC will issue rules requiring disclosure in the annual proxy statement explaining the company’s decision either to have one person serving in both roles or separate persons in those roles.

Risk Committee

Nonbank financial companies that are supervised by the Federal Reserve Board (“Board”), along with publicly traded bank holding companies with total consolidated assets of at least $10 billion in assets, will be required to establish a risk committee of the board. The risk committee is responsible for the oversight of enterprise-wide risk management practices. The Board is required to issue regulations implementing this requirement. In addition, the Board may require smaller publicly-traded bank holding companies to do the same if the Board determines that it is necessary and appropriate to promote sound risk management practices. The Board will establish independence standards for the risk committee, including the number of independent directors it should have and that it include at least one risk management expert who has experience with managing risks of large, complex firms.

To review the text of the Act see sections 951-957, 971, 972, and 165(h) by clicking on this link to the Act:

The information contained in this CBA Regulatory Compliance Bulletin is not intended to constitute, and should not be received as, legal advice. Please consult with your counsel for more detailed information applicable to your institution.

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