What’s New for the 2011 Proxy Season

In effect for the first time this proxy season are the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) provisions requiring shareholder say on pay, say on frequency and say on golden parachute compensation advisory votes. While most of the focus for the upcoming proxy season will be on these new advisory votes, companies will also want to keep in mind the comments issued by the SEC in 2010 regarding proxy statement disclosures, as well as the voting policies of Institutional Shareholder Services Inc. (“ISS”) regarding various compensation and governance matters. In anticipation of SEC rulemaking regarding hedging and clawback policies, companies may also want to consider reviewing their existing policies, or adopting new policies, and consider how those policies will be addressed in the 2011 proxy statement.

Say on Pay

The new mandatory say on pay proposal is required in annual meeting proxy statements for shareholder meetings occurring on or after January 21, 2011. The SEC released proposed rules on October 18, 2010, which have not been finalized yet. As discussed in our Corporate Update dated October 22, 2010, available at http://www.dorsey.com/eu_corp_sayonpay_102110 (the “October Corporate Update”), proposed Rule 14a-21(a) requires a shareholder advisory vote to approve executive compensation at least once every three years. This new advisory vote and related disclosures merit a meaningful investment of time and thought. Outlined below are steps companies should take in light of this new requirement.

Assess Pay Practices. Each company should begin preparing for say on pay by reviewing the current linkages between its executive pay and performance and analyzing how its executive pay compares to pay at the company’s peers. Companies should assess whether they expect the shareholder vote to be favorable and consider having discussions with significant shareholders, including institutional holders, as well as proxy solicitation firms and compensation consultants. Companies should also consider whether investors or proxy advisory firms have characterized any of their compensation arrangements as “problematic” pay practices and review prior assessments by ISS, including ISS’s GRId governance rating scores.

Revise CD&A. Companies should revise their Compensation Discussion and Analysis (“CD&A”) disclosures this year to make the relationship between actual pay and performance more clear and convincing to shareholders. We recommend including an executive summary at the beginning of the CD&A which would serve as the supporting statement for the compensation paid in the last year. To that end, the executive summary should:

• Emphasize the relationship of pay to performance;
• Describe briefly the business results for the last year, focusing in particular on the performance measures used to determine any annual and long-term incentive compensation;
• Use tables and graphs for key performance measures and results;
• Explain how performance of the company’s business affected the compensation actions and decisions taken with respect to senior executives;
• Summarize key compensation actions involving the CEO and the CEO’s key accomplishments for the fiscal year; and
• Describe any significant compensation policies and practices that have been implemented or revised since the last annual meeting, highlighting specifically any shareholder-friendly compensation changes and best practices.

The CD&A in its entirety should tell the company’s compensation story in a clear and compelling way. The compensation philosophy and process discussions should be streamlined, and the compensation component descriptions should be presented concisely. The CD&A should contain clear discussions regarding perquisite policies and post-employment compensation arrangements and address any problematic pay practices head-on.

Prepare Proxy Statement Proposal. The SEC’s proposed rule does not require any specific language to be included in the proxy statement proposal regarding say on pay but does require that the proposal make clear that the vote is based on all of the executive compensation disclosures contained in the proxy statement pursuant to Item 402 of Regulation S-K, including the CD&A and narrative and tabular disclosures. Proposed Item 24 to Schedule 14A requires disclosure as to why the say on pay vote is being conducted and the effect of such vote, including the fact that it is non-binding. The SEC has proposed an amendment to Item 402(b) of Regulation S-K that will require disclosure in future CD&As regarding whether and how the company’s compensation policies and decisions reflect the results of past say on pay votes. No preliminary proxy statement filing is required as a result of the say on pay proposal.

Say on Frequency

Also required in proxy statements for annual meetings held on or after January 21, 2011 is a proposal allowing shareholders to vote regarding the frequency of the say on pay vote (a “frequency vote”). See our October Corporate Update. Proposed Rule 14a-21(b) requires shareholders to be given the opportunity to vote regarding whether the say on pay vote should be conducted every year, every two years or every three years. Pursuant to the Dodd-Frank Act, a frequency vote must be conducted at least once every six years.

Determine Board Recommendation. The main task for companies is to determine whether to include a recommendation regarding the frequency vote in the proxy statement and, if so, what that recommendation should be. In making this determination, companies should review how their shares are held and consider communicating with larger investors to gauge if they have a preference regarding the frequency vote. Some proxy advisor firms and large institutional investors have issued or will issue policies regarding the frequency vote. ISS, for example, has adopted a policy supporting annual advisory say on pay votes. Companies will also need to assess whether they anticipate shareholder approval difficulties in light of performance or problematic pay practices and assess the risk of retaliatory votes against compensation committee members in any year when the say on pay advisory vote is not conducted. Companies will also want to consider the frequency vote recommended by peer companies. It is too early in the current season to determine what the prevalent practice will be on the frequency vote.¹

Prepare Proxy Statement Proposal. The SEC’s proposed rule requires companies to provide four choices in the proposal with respect to how often the say on pay vote should be held – every year, every two years, every three years, or abstain from voting – rather than a choice to approve or disapprove a company recommendation regarding the frequency vote. Proposed Item 24 to Schedule 14A requires proxy statement disclosure as to why the frequency vote is being conducted and the effect of such vote, including the fact that it is non-binding. The proposed rules would also require disclosure of the company’s decision on the frequency vote in light of the shareholders’ advisory vote in the Form 10-K or Form 10-Q for the period covering the annual meeting. No preliminary proxy statement filing is required as a result of the say on frequency proposal.

Say on Golden Parachutes

Proposed Rule 14a-21(c) requires a shareholder advisory vote to approve certain golden parachute arrangements disclosed pursuant to Item 402(t) of Regulation S-K in business combination proxy statements. The requirement for this vote would not apply to a target issuer if it has previously included the golden parachute disclosure in its annual meeting or other proxy statement which included a say on pay advisory vote. See our October Corporate Update. Proposed Item 402(t) details new golden parachute disclosure requirements. The new disclosure requirements include both narrative and tabular disclosure of all elements of golden parachute compensation as well as disclosure of the total of all golden parachute compensation.

The golden parachute disclosures and advisory vote will be required on or after the later of January 21, 2011 or the date on which the related proposed rule and amendments are effective. Companies will want to consider the advantages and disadvantages of including the golden parachute disclosures in their annual meeting proxy statements. We do not expect many companies to include the additional disclosures this year.

Elimination of Broker Discretionary Voting on Executive Compensation Matters

Pursuant to Section 957 of the Dodd-Frank Act, in September 2010, the SEC approved amendments to NYSE Rule 452 and NASDAQ Rule 2251, which govern discretionary voting by brokers of shares held in street name when the beneficial owners have not provided instructions regarding how the shares should be voted. As amended, NYSE Rule 452 and NASDAQ Rule 2251 provide that executive compensation matters (including the say on pay, frequency and golden parachutes votes) are non-routine matters. Therefore, brokers cannot vote shares on such matters without specific instructions from the beneficial owner. Companies should assess the impact that these amendments may have on their shareholder votes regarding executive compensation and consult with proxy solicitation firms and other advisers as necessary.

Other Actions to Consider for the 2011 Proxy Season

Hedging Policy. New subsection (j) to Section 14 of the Securities Exchange Act of 1934 (the “Exchange Act”) requires the SEC to issue rules requiring public companies to disclose in their proxy statements whether directors and employees are permitted to hedge the value of equity securities held directly or indirectly by the director or employee. While waiting for the SEC’s proposed rules, which are scheduled to be released between April and July of 2011, companies with hedging policies should consider modifying their policies in light of Section 14(j) and companies without hedging policies should consider adopting hedging policies. Companies should also consider adding disclosure to the proxy statement regarding the adoption or modification of hedging policies.

Clawback Policy. New Section 10D of the Exchange Act requires the SEC to adopt rules prohibiting the listing on a national securities exchange of any issuer that has not adopted a clawback policy consistent with the section. The clawback policy required under the section would force issuers to recover from any current or former executive officer any incentive compensation that was paid during the three years preceding any accounting restatement due to material noncompliance with reporting requirements, to the extent it exceeds the compensation that would have been paid based on the restated financials. Section 10D also requires the SEC to adopt rules that require the issuer to develop a policy relating to disclosure of the clawback policy, presumably in the annual proxy statement. While waiting for the SEC’s proposed rules, which are scheduled to be released between April and July of 2011, companies with existing clawback policies should review their policies against the requirements of Section 10D and determine how the proxy disclosure regarding the policies may need to be revised. Companies without existing clawback policies should consider adopting a clawback policy and disclosing the policy in their proxy statement.

Timeline of Other Corporate Governance Provisions of the Dodd-Frank Act

Set forth below is a table outlining the timeline and next steps for the other corporate governance provisions of the Dodd-Frank Act, all of which remain subject to SEC rulemaking.

Proxy Access

In October 2010, the SEC announced that it would stay the effectiveness of the new proxy access rules pending resolution of a petition filed by the U.S. Chamber of Commerce and the Business Roundtable with the U.S. Court of Appeals for the D.C. Circuit. See our Corporate Update dated October 5, 2010, available at http://www.dorsey.com/eu_sec_effective_proxy_100510/ Rule 14a-11, which was to become effective on November 15, 2010, would have required public companies to permit a shareholder or group of shareholders owning at least 3% of a public company’s voting stock for at least three years to include director nominees in company proxy materials.

It is unclear when and how the legal issues raised in the petition will be resolved. In any event, the proxy access rules are not expected to be in place in time for the 2011 proxy season. While the decision is pending, companies should assess their likelihood of facing a shareholder-backed Board nominee and may want to have discussions with institutional holders, proxy solicitation firms and other advisers in this regard. If the new Rule 14a-11 survives the legal challenges, companies will want to develop systems for processing shareholder nominees and review related provisions of their bylaws, corporate governance guidelines and Board committee charters.

SEC Comments and Interpretations

Companies should review and update as appropriate their proxy statement disclosures to address recent SEC comments and interpretations. Set forth below is a summary of SEC comments frequently given in 2010 relating to proxy statement disclosures:

• Compensation Risk Assessment. The SEC frequently asked companies to describe the process they followed in assessing whether the companies’ compensation policies and practices were reasonably likely to have a material adverse effect on the companies, as required by Item 402(s) of Regulation S-K. This comment was given regardless of whether companies included the optional negative disclosure that the compensation policies and practices were not reasonably likely to have a material adverse effect.
• Board Leadership Structure. In regard to the Board leadership structure disclosure required for the first time in 2010 pursuant to Item 407(h), the SEC frequently issued comments asking a company to explain why its Board leadership structure is appropriate for that company and how the Board’s role in risk oversight has affected the Board’s leadership structure.
• Director Qualifications. In 2010, pursuant to Item 401(e), companies were required for the first time to discuss what experiences, qualifications, attributes or skills led to the conclusion that each director or director nominee should serve on the companies’ Boards. The SEC issued comments to companies that recited directors’ resumes rather than discussing the director’s experiences, attributes and skills, as required by Item 401(e), or that failed to explain specifically why each director or director nominee should serve on the company’s Board.
• Diversity Policy. For companies that included proxy disclosure last year regarding the Nominating Committee’s consideration of diversity in identifying director nominees in accordance with Item 407(c)(2)(vi), the SEC frequently issued comments asking the companies to describe how the diversity policy is implemented and how the Nominating Committee assesses the effectiveness of the policy.

Companies should also review the SEC’s updated Compliance & Disclosure Interpretations (“C&DIs”) relating to Regulation S-K. The updated C&DIs are available at http://www.sec.gov/divisions/corpfin/guidance/regs-kinterp.htm and, as always, should be consulted for applicable updates when preparing proxy statement disclosures.

ISS 2010 Postseason Report and 2011 Voting Policy Updates

The last proxy season can serve as a useful guide when analyzing what to expect this proxy season. Companies should review the “2010 U.S. Postseason Report” issued by ISS to better understand the 2010 proxy season trends. This report (available at http://www.issgovernance.com/docs/2010USPostSeasonReport²) reveals that:

• Although broker discretionary voting on director elections was eliminated, about the same number of directors received majority opposition in 2010 as in 2009, and the average dissent rate declined year-over-year.
• For S&P 500 companies, the primary reasons for director withhold votes were majority-supported shareholder proposals that were not adopted by Boards and compensation concerns. For Russell 3000 and small-cap companies, the most common reasons for director withhold votes were problematic pay practices, pay for performance disconnects, concerns regarding director independence and meeting attendance and adoption of a poison pill without shareholder approval.
• Average support for say on pay advisory votes in 2010 was 89.6%. The most common reasons for ISS disapproval recommendations on management say on pay proposals were pay for performance disconnects, excessive salary increases and issues relating to change in control practices.
• Shareholders continued to show strong support for shareholder proposals seeking majority voting on directors, declassification of Boards and repeal of supermajority voting requirements.
• Shareholder proposals seeking the right to call special meetings, independent Board chairs and cumulative voting received less support in 2010.
• Shareholder support for environmental and social shareholder proposals continued to increase in 2010.
• There were fewer proxy contests in 2010 in comparison to the prior year.

In November 2010, ISS published its 2011 U.S. Corporate Governance Policy updates, which will be effective for shareholder meetings held on or after February 1, 2011. Included in the updates were two new policies regarding frequency of say on pay votes and regarding proposals to approve golden parachute compensation. Existing policies that were updated related to companies’ responsiveness to majority-supported shareholder proposals, director attendance, shareholders’ ability to act by written consent, problematic pay practices and net operating loss poison pills. Companies should familiarize themselves with these policy updates as they prepare for the upcoming proxy season. An executive summary and the complete set of policy updates are available at http://www.issgovernance.com/policy/2011/policy_information.

Periodic Reports

Finally, there are a few new items that companies will need to take into account during 2011 when preparing periodic reports.

Liquidity and Capital Resources Disclosure in MD&A. In preparing the liquidity and capital resources disclosures in the Management Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) section of the Form 10-K, companies should consider the guidance included in the SEC’s interpretative release (SEC Release No. 33-9144) issued in September 2010, which was intended to improve investors’ understanding of the liquidity and funding risks faced by companies. The interpretive release:

• Reiterates long-standing MD&A principles as they apply to disclosure of critical liquidity matters;
• Makes clear that a company cannot use financing structures (whether "on-balance sheet" or "off-balance sheet") designed to mask the company's reported financial condition;
• Emphasizes that leverage ratios and other financial measures included in SEC filings must be calculated and presented in a way that does not obscure the company's leverage profile or reported results; and
• Addresses divergent practices that have arisen regarding disclosures in the contractual obligations table and encourages companies to focus on providing informative and meaningful disclosure about their future payment obligations.

XBRL Mandate. In December 2008, the SEC voted to require specified companies and mutual funds to provide financial statements, notes and schedules to the SEC in an interactive data format which uses eXtensible Business Reporting Language (“XBRL”). Large accelerated filers who file using U.S. GAAP and who have a public float above $5 billion were required to make XBRL filings for their first quarterly reports for fiscal periods ending on or after June 15, 2009. All other large accelerated filers who file using U.S. GAAP were required to make XBRL filings for their first quarterly reports for fiscal periods ending on or after June 15, 2010. All remaining companies who file using U.S. GAAP (including smaller reporting companies) will be required to make XBRL filings for their first quarterly reports for fiscal periods ending on or after June 15, 2011. Companies reporting in IFRS issued by the International Accounting Standards Board will also be required to submit XBRL filings starting with fiscal years ending on or after June 15, 2011.

Exhibit 10 Material Contracts. SEC rules require that material contracts filed pursuant to Item 601(b)(10) of Regulation S-K include all schedules, exhibits and similar attachments in the filing. The SEC has been issuing comments to companies that have omitted such schedules, exhibits or attachments without submitting a narrowly-tailored confidential treatment request regarding the omitted information. Companies should keep this in mind as they file material contracts with periodic reports this year and consider whether already-filed material contracts that omitted information should be refiled with the Form 10-K.

Non-Accelerated Filers Exempted from 404 Reports. Section 989G of the Dodd-Frank Act made permanent the relief afforded non-accelerated filers under Section 404(b) of the Sarbanes-Oxley Act of 2002. A new Section 404(c) was added to the Sarbanes-Oxley Act providing that the auditor attestation requirement of Section 404(b) will apply only to accelerated filers and large accelerated filers. Non-accelerated filers will not be required to include in their annual reports an attestation report of their independent auditor on internal control over financial reporting.

Disclosure Regarding Frequency Vote in Periodic Reports. Proposed amendments to Form 10-K and Form 10-Q require disclosure in the report covering the period during which the advisory vote is held regarding the company’s action as a result of the frequency vote and whether the company will follow the shareholder recommendation.

¹Of the 19 companies that filed annual meeting proxy statements between November 19, 2010 and December 16, 2010, which included 16 large accelerated filers, 13 recommended a triennial vote, one recommended a biennial vote, four recommended an annual vote (including all three smaller companies), and one made no recommendation.
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