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The article below was published in Agenda, a Financial Times private subscription service for corporate directors, and is presented with permission.


Agenda, July 26, 2010 article


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Article published on July 26, 2010
Josh Martin

Ambiguities in the say-on-pay provisions of the Dodd-Frank Act, calling for shareholder approval of executive compensation and a second vote on the frequency with which such approval is sought, are raising calls for the SEC to clarify both events.

Under Section 951, the act itself does not mandate that the SEC write new rules for conducting these votes. It calls for “a separate resolution subject to shareholder vote to determine whether votes… will occur every 1, 2 or 3 years,” with the vote on frequency to be held not less than once every six years.

“On its face, the statute appears to require that shareholders have the right to vote on which of the three [frequency] alternatives they prefer, not merely to vote for or against the company’s preference,” says Jim Barrall, partner at Latham & Watkins.

But the way the law is written raises questions about what management can do. “Under basic corporate law, management can recommend, but leave the choice to shareholders,” says Mark Poerio, partner at Paul Hastings. “Section 951 seems to want investors to have the choice of frequency, but it doesn’t preclude management from advocating one of the three choices.”

“Boards will have the ability to present their preference,” says Sanjay Shirodkar, a former special counsel at the SEC and currently of counsel at DLA Piper.

The language of the law, say experts, leaves a loophole that could permit companies to press for shareholder votes on the frequency of say-on-pay every year, until the desired result is achieved.

Poerio notes that this ambiguity might require SEC clarification. “It is unclear whether a company can use its discretion to hold subsequent frequency votes if it doesn’t initially get the say-on-pay frequency vote results that it wants,” he says. The SEC, he points out, might need to develop model text (as it did with TARP say-on-pay votes) requiring an up-front disclosure that addresses when the next frequency vote will appear, regardless of the initial outcome.

But other experts note that the model text itself might not be mandatory. “In TARP, the SEC did not mandate the language of say-on-pay voting in the proxies,” recalls Shirodkar. “They just said that companies have to include it.”

Under Title VII of the American Recovery and Reinvestment Act of 2009, banks rescued by money infused through the TARP program were compelled to hold annual say-on-pay votes.

Whereas many directors appear to advocate biennial or triennial votes, that support is not universal. “One size does not fit all,” explains Shirodkar. “If you go for annual votes, the board could foster better investor relations.”

At the signing ceremony making say on pay the law of the land, President Barack Obama acknowledged: “We... may need to make adjustments along the way as our financial system adapts to these changes.”

Dodd-Frank Reform Prompts New Comp

 Checklists, Inventories

Even before the SEC issues new rules clarifying key governance passages of the Dodd-Frank Act, consultants and lawyers are developing checklists to enable boards to adjust compensation packages in order to secure a high number of favorable say-on-pay votes.

“Boards need to take an inventory of compensation policies and ask if they show a strong link between executive pay and a company’s performance,” says Sanjay Shirodkar, a former special counsel at the SEC and currently of counsel at DLA Piper.

Shirodkar’s checklist for compensation committees includes:

• Look more carefully at metrics to make sure they underscore the importance of linking pay with performance

• Re-examine contracts to be on the lookout for potentially oversize payouts in severance and change-in-control events

• Look out for triggers on the exercise of tax gross-ups

Compensation consultants have a different perspective.

“We are encouraging our clients to do a strategic mapping of their large institutional shareholders,” says Irv Becker, national practice leader at Hay Group. “It can result in a constructive, proactive discussion. It lets the company know what the hot-button issues are and lets them adjust compensation plans accordingly.”

Becker adds that while there are many comp elements to consider, boards have to take a broad view before focusing on specific problem areas, in particular compensation plans. At that point, he suggests a hot-button inventory should include:

• Perquisites

• Gross-ups

• Severance programs

• Change-in-control agreements

• Supplemental executive retirement plans

Both lawyers and consultants agree: Boards need to make sure the language used to present any compensation plan subject to a shareholder vote is clear.

“If you have practices that register high negatives with investors, make sure there are strong reasons to keep them,” advises Dan Ryterband, president of Frederic W. Cook & Co.

Stockholders will be reviewing both the information about executive compensation and — perhaps more importantly — the company’s explanation as to the compensation paid to the executives in considering how they will vote under say on pay.

“You’ll have to rework the CD&A to make sure it is understandable,” says Shirodkar. “The say-on-pay process will accomplish what the SEC originally sought under its CD&A disclosure rules three years ago.”



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