Employee Benefits Update

Dodd-Frank Executive Compensation and Corporate Governance Provisions

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) was signed into law. The Act provides for significant changes regarding executive compensation and related disclosures as well as corporate governance. The Securities and Exchange Commission (“SEC”) may exclude small companies from application of certain provisions of the Act; however, the Act will affect almost all publicly-traded companies, as well as certain private financial institutions. Many provisions of the Act require additional rules and guidance from the SEC and/or national securities exchanges prior to implementation.

Some highlights of the executive compensation and corporate governance provisions of the Act include:

• Say on Pay. Shareholders must be given a non-binding advisory vote on compensation (“say on pay”) paid to named executive officers (“NEOs”). At the time of the first say on pay vote, shareholders will also be given the opportunity to decide whether to have say on pay votes every one, two or three years. At least once every six years thereafter the company must allow shareholders to determine again the frequency of say on pay votes. In addition, in any proxy solicitation where shareholders are asked to approve a transaction, NEO compensation as a result of the transaction must be disclosed in a “clear and simple form,” and shareholders must be given a non-binding advisory vote on such compensation unless shareholders have had an opportunity previously to give a non-binding vote on the compensation arrangements. The say on pay advisory vote and frequency of submission to shareholders must be a part of any proxy or other solicitation for the first shareholder meeting after January 21, 2011.
• Clawback Policies. Under to-be-issued national exchange rules, publicly-traded companies must adopt a clawback policy that is broader than current clawback rules under the Sarbanes-Oxley Act of 2002. The clawback policy must provide that, if a company is required to prepare an accounting restatement in connection with material noncompliance with any financial reporting requirement, the company will recover any “excess” incentive-based compensation that a current or former executive officer received in the three years prior to the restatement.
  
• Executive Compensation Disclosures. The Act expands executive compensation disclosure. Disclosures of executive compensation must include information that shows the relationship between the compensation actually paid and the company’s financial performance, taking into account changes in stock price and dividends and distributions. Companies must also disclose median annual total employee compensation for employees other than the chief executive officer (“CEO”), annual total compensation of the CEO and the ratio of the two. Disclosures must also discuss the reasons why a company has chosen the same individual, or different individuals, to serve as CEO and Chairman of the Board. Companies must disclose policies addressing whether employees are allowed to hedge their holdings in company equity securities. The effective dates of these provisions will be determined by future SEC rules.
  
• Compensation Committee Independence. Several provisions of the Act address “independence” of compensation committees. Members of a compensation committee, as well as their consultants and advisors, must meet independence standards to be developed by next summer. It is not clear how the independence standards may differ from existing national exchange standards. Additional disclosures will be required where independence standards are not met.
  
• Broker Discretionary Voting. The Act will end broker discretionary voting in any board election, in any vote with respect to any executive compensation issues and in other areas to be determined. This provision takes effect immediately, pending issuance of SEC transition rules.
  
• Other Features. The Act permits, but does not require, the SEC to issue rules related to shareholder access to proxy materials for the purposes of shareholders nominating director candidates. The Act also requires certain financial institutions, whether public or private, to disclose sufficient information regarding all incentive compensation arrangements so that regulators can determine whether the compensation is excessive or could lead to material financial loss, and practices that are deemed to encourage inappropriate risks will be prohibited.

Key Concerns: The change to broker discretionary voting may be a significant factor in a company’s ability to adopt incentive and other compensation plans. While the future rules will need to be analyzed, the disclosures regarding the ratio between the median employee and the CEO total compensation are potentially burdensome. In addition, there is little doubt that as the rules are formed, institutional shareholders, as well as institutional shareholder services groups such as RiskMetrics Group, will develop voting guidelines and voting recommendation guidelines based on the requirements of the Act and “best practices.” In particular, the frequency of say on pay voting and the total annual compensation ratio offer prime opportunities for these constituencies to attempt to dictate best practices standards and measurements.

Companies should start to consider how the requirements of the Act will affect, in general, their current governance practices, executive compensation arrangements and future proxy disclosures. For example, companies may now want to review compensation committee and advisor independence, consider how to describe executive compensation disclosures in a “best light” with respect to say on pay and begin reviewing alternatives related to clawback policies.

A link to the complete text of the Act can be found here. A Baker Botts update addressing the whistleblower provisions of the Act can be found here.

IRS Circular 230 Disclaimer: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.