by Kevin Douglas and Jamie Wade, Bass, Berry & Sims PLC
On May 20, 2010, the U.S. Senate passed the Restoring American Financial Stability Act of 2010, which contains a number of significant corporate governance and executive compensation provisions impacting public companies. In mid-June, Senate and House negotiators began reconciling the Senate bill with the Wall Street Reform and Consumer Protection Act of 2009 which passed the House last December, with the goal of presenting a bill to President Obama prior to the July 4th recess.
With respect to corporate governance, the Senate bill would require majority voting in uncontested director elections for all companies listed on a national securities exchange. The Senate bill would also authorize the Securities and Exchange Commission to adopt proxy access rules whereby a shareholder could include its own director nominees in a company’s proxy statement. Based in part on this authority, it is expected that the SEC will adopt final proxy access rules following the enactment of this legislation (the SEC adopted proposed proxy access rules in June 2009).
The Senate legislation also includes the following significant executive compensation provisions:
- A requirement that all public companies hold an annual nonbinding vote on executive compensation ("say-on-pay");
- A prohibition on brokers exercising discretionary voting authority without instructions from beneficial owners on any matter relating to executive compensation, including say-on-pay (following a similar prohibition on brokers voting uninstructed shares in uncontested director elections that was adopted by the SEC effective January 1 of this year);
- A requirement that companies listed on national securities exchanges adopt clawback provisions for incentive compensation following certain financial restatements; and
- The adoption of additional compensation-related disclosures by public companies, including requirements that companies disclose (1) the ratio between CEO total compensation and the median total compensation of all other employees of the company and (2) the relationship between executive compensation and the financial performance of the company.
It is expected that final legislation will include both say-on-pay and proxy access provisions. The other executive compensation provisions described above were not included in the House bill, and it is currently unclear which of these provisions will be included in final legislation. Moreover, there is uncertainty regarding whether mandatory majority voting (which was not included in the House bill) will be included in final legislation.
A relatively small (though increasing) percentage of public companies have submitted management say-on-pay proposals to their shareholders in 2010. Most management say-on-pay proposals have received overwhelming shareholder support, but three prominent U.S. companies (KeyCorp, Motorola and Occidental Petroleum) failed to receive majority support this year in connection with say-on-pay proposals.
The adoption of proxy access will likely increase the number of contested director elections and the number of companies subject to director election campaigns initiated by special interest shareholders. Moreover, mandatory majority voting, if adopted, will likely increase the number of companies subject to “vote no” campaigns by disgruntled shareholders and the leverage of shareholders in conducting these campaigns.
Mid-cap and small-cap companies will be particularly impacted by these reforms. A significant majority of mid-cap and small-cap companies (unlike large-cap companies) have not yet adopted majority voting. In addition, mid-cap and small-cap companies often have a significant retail shareholder base. Historically, most retail shareholders (who tend to vote overwhelming in favor of management) do not vote unless prompted by active solicitation efforts, and companies with a sizeable retail shareholder base may experience a significant drop in the number of shares voted in favor of management in uncontested director elections and (if the Senate provision becomes law) say-on-pay matters.
Taken together, say-on-pay, proxy access and (if enacted) mandated majority voting are likely to continue to increase the influence of activist shareholders and proxy advisory services such as ISS. In response to these developments, we advise public companies to:
- Be prepared for even greater scrutiny of their executive compensation practices, and to revisit their proxy statement compensation disclosures in light of say-on-pay;
- Maintain an ongoing dialogue with significant shareholders;
- Understand the voting practices of significant shareholders (including the extent to which they follow the recommendations of proxy advisory firms);
- Be mindful of the voting recommendations and significant influence of proxy advisory firms such as ISS; and
- Be prepared to engage in more active solicitation efforts to help stem the anticipated decrease in their retail vote.
Kevin Douglas is a partner in the Corporate and Securities practice area at Bass, Berry & Sims PLC, in Nashville, Tennessee, and counsels companies on merger & acquisitions, corporate governance and securities matters, with a particular focus on shareholder activism-related matters. Jamie Wade is an associate in the Corporate and Securities practice area at Bass, Berry & Sims PLC, in Nashville, Tennessee, with a focus on executive compensation.
Topic tags: boards of directors, financial reform, majority voting, say-on-pay