Executive Compensation Alert

Executive Compensation Alert Inside Financial Reform Bills Passed Awaiting Reconciliation Introduction Executive Compensation Say on Pay Vote on Golden Parachutes Compensation Committee Independence Consultant and Advisor Independence Enhanced Compensation Disclosures Clawbacks Hedging Special Financial Institutions Compensation Rules Corporate Governance Majority Vote Broker Discretionary Voting Proxy Access Alert 2010-02 Conference Committee Deciding Fate of Passed Financial Reform Bills Both Houses of Congress have now passed financial reform bills with major executive compensation and corporate governance provisions. Because of differences in the bills, they will have to go to a conference committee to be reconciled. In the Senate, S. 3217, Restoring American Financial Stability Act of 2010, passed with a 59-39 vote. This 1,000 plus page bill was sponsored by Sen. Christopher Dodd (D-CT). In the House, H.R. 4173, Wall Street Reform and Consumer Protection Act of 2009, an equally voluminous bill sponsored by Barney Frank (D-MA), passed last December with a 223 202 vote. The conference members are free to rewrite any provision. Upon completion of the reconciliation, the final product goes to each house for an up or down vote. No amendments are permitted. Congressional leaders have indicated that they would like to have a final bill to the President for signing by July 4. While we do not claim to have a functioning crystal ball, we feel safe in predicting that some of the provisions will be enacted and impact executive compensation, possibly as soon as the next proxy season. The specific provisions affecting executive compensation and corporate governance are discussed below. Executive Compensation Say on Pay The Senate bill provides that public companies would be required to provide shareholders with a nonbinding advisory vote on their executive compensation proxy disclosure, a say on pay provision. The House bill also provides for a mandatory say on pay vote. The main difference between the bills is the effective date. In the Senate bill, the provision would become effective for shareholder meetings occurring six months after passage of the bill (in time for next proxy season). The House bill calls for the SEC to issue rules for say on pay within six months of enactment, with the say on pay rules effective six months after the SEC issues its final rule. Hewitt Comment: Say on pay votes have already been implemented at many large U.S. companies and this provision is similar to others that have been previously proposed. Over 80 non-tarp companies have already voluntarily provided, or will be providing, shareholders with a nonbinding advisory vote on pay at their annual meetings. Additionally, financial institutions that have not yet repaid TARP funds are required to give shareholders the right to a nonbinding advisory vote on executive compensation disclosures at their annual meetings. It would appear that the U.S. will have mandatory say on pay, the only question being whether it will be implemented for the 2011 proxy season or delayed until 2012. Chair/CEO Structure Copyright 2010 Aon Hewitt 1 June 7, 2010 / Alert

Unlike last year when all executive pay proposals put to a shareholder vote passed, this year we have seen two voluntary management proposals rejected and one TARP-mandated proposal fail to get majority support. Motorola shareholders gave the say on pay advisory vote only 46% support. Occidental Petroleum's say on pay proposal received 47% support. Key Corp., an Ohio bank, became the first company to receive less than majority support for a TARP-mandated advisory vote on executive pay. Key Corp. shareholders gave only 45% support to the management say on pay proposal. Last year, of the nearly 20 non-tarp companies who voluntarily provided say on pay proposals, average support was 87%. For TARP companies that were required to provide a say on pay resolution in 2009, average support was 89%. Vote on Golden Parachutes The House bill provides that, when a company is seeking the approval of shareholders for a merger, acquisition, or other consolidation or sale of the company, the shareholders must also be given the right to a non-binding vote on any executive compensation agreement concerning any type of compensation, be it present, deferred, or contingent, that is related to the merger, acquisition, or other consolidation or sale of the company. In other words, shareholders get to vote on golden parachutes. Like the say on pay vote, this one would also be nonbinding on the board of directors. There is no similar provision in the Senate bill. Hewitt Comment: The prospects for a mandatory vote on golden parachutes are uncertain at this time. A provision like this may very well be a bargaining chip for both supporters and detractors if negotiations are prolonged. At the time shareholders are voting on a merger or acquisition, they are more concerned with the impact on share price than on a parachute payment. Compensation Committee Independence Both bills require that compensation committees consist only of independent directors. To further that independence, the House bill provided that the SEC is to propose rules that would require listing exchanges to mandate that compensation committee members may not accept "any consulting, advisory, or other compensatory fee from the issuer." Under the Senate bill, the SEC would be directed to adopt a rule that all national stock exchanges must amend their listing standards to require all listed companies to maintain an independent compensation committee. The SEC would be authorized to make appropriate exceptions. The House bill mandates that compensation consultants and similar advisors to the compensation committee meet independence standards set by the SEC. In addition, compensation committee must have sole authority to appoint compensation consultants and other advisors. The compensation committee would be directly responsible for oversight and compensation of the consultants and advisors. Companies are required to disclose whether a compensation consultant was retained by the compensation committee. The Senate bill does not contain any specific requirements on the independence of compensation consultants or advisors. However, the Senate bill does say that consultant and advisor independence is a factor to be considered when selecting advisors (see below). Hewitt Comment: Existing Exchange and SEC rules effectively accomplish this now. We do not anticipate that this will cause any hardship for the vast majority of public companies. Copyright 2010 Aon Hewitt 2 June 7, 2010 / Alert

Compensation Consultant and Other Advisor Independence The legislation in the House states that compensation committees who employ consultants or other similar advisors or counsel must ensure that the consultant, advisor, or counsel meets standards of independence that will be mandated by the SEC. Compensation committees are required to disclose whether they "retained and obtained the advice of a compensation consultant meeting the standards for independence." The SEC is instructed to ensure that any regulations mandating consultant independence are to be "competitively neutral among categories of consultants and preserve the ability of compensation committees to retain the services of members of any such category." The House bill requires the SEC to report to Congress within two years of the date the SEC rules are in effect on a study of the use of independent compensation consultants. The independent compensation consultant disclosure requirements become effective no earlier than one year after the effective date of the legislation's enactment. Under the Senate bill, the SEC is instructed to identify factors that may impact the independence of compensation consultants, legal counsel, or other advisors. Compensation committees may only select a compensation consultant, legal counsel, or other advisor after taking into consideration the factors identified by the SEC. The Senate bill lists the following factors that the SEC must include: Other services provided by the consultants or advisors companies; The amount of fees paid to the consultants and advisors companies as a percentage of total revenue; Policies and procedures in effect to avoid conflicts of interest; Business or personal relationship of the compensation consultant, legal consultant, or other advisor with members of the compensation committee; and Any stock of the issuer owned by the compensation consultant, legal counsel, or other advisor. The bill would affirm the right of the compensation committee to use its discretion to retain compensation consultants. Any such retained compensation consultant must be disclosed in the company s proxy along with a statement acknowledging any conflict of interest, the nature of the conflict, and how it is being addressed. This provision would be effective one year after the date the legislation is effective. Hewitt Comment: Many of these provisions were included in the SEC s December 2009 proxy disclosure requirements that were in effect for most companies with a calendar year fiscal year. The proxy disclosures being generated now are already disclosing many of the factors that the bill is seeking to have the SEC adopt. (See Hewitt Executive Compensation Alert 2009-12 for a detailed explanation of the new SEC disclosure rules.) The legislation makes clear that compensation committees are not required to obtain and use the services of a compensation consultant; however, use of compensation consultants is already a clear majority practice. Enhanced Compensation Disclosures Under the Senate bill, the SEC would be directed to issue rules requiring public companies to disclose in their proxies the relationship between executive compensation and the financial performance of the company. This disclosure must include a graph or other pictorial comparison of the amount of executive compensation paid over a five-year period compared to the financial performance of the company or the return to investors during that same period. There is no equivalent provision in the House bill. Copyright 2010 Aon Hewitt 3 June 7, 2010 / Alert

The Senate bill also requires that companies must disclose: The median total compensation of all employees, with the exception of the CEO; The CEO s annual total compensation; and The ratio of the median annual employee total compensation to that of the CEO In calculating the annual compensation for all employees, the company is to use the same criteria for calculating annual compensation for the Summary Compensation Table. There is no comparable provision in the House bill. Hewitt Comment: If part of the final bill, this could be a substantial and costly administrative burden for companies. Clawbacks Under the Senate bill, all covered companies would be required to adopt clawback provisions that would recoup incentive-based compensation where the company was forced to restate its financial statements for any year during the preceding three-year period. The clawback policy would apply to all executive officers, both current and former, for a three-year period preceding the restatement. The amount to be recouped would be any incentive-based compensation, including options, in excess of the amount that would have been payable after taking into consideration the restatement. Unlike many of the existing clawback policies now in effect, this clawback is triggered even if there is no misconduct on part of the executive. The House bill specifically states that clawbacks are neither required nor prohibited under the legislation. Hewitt Comment: Our data shows that 73% of the FORTUNE 200 companies reported having a clawback policy. Clearly, this has already become a best practice for public companies. However, there is a great disparity among companies in defining what triggers a clawback, with many companies limiting clawbacks to those executives whose actions resulted in the restatement. The Senate bill makes no reference to executives having culpability before they are subject to clawbacks nor does it indicate how the clawback provision would actually be enforced. If this proposed provision becomes law, some employers may consider deferring payments of incentive awards to make sure they have the ability to reverse an award following a restatement. Employee Hedging Under the Senate bill, public companies would be required to disclose if their employees or directors are eligible to purchase financial instruments that are designed to hedge or offset any decrease in the market value of equity that is part of the employees compensation package. The House bill does not address employee hedging. Hewitt Comment: Our data shows that nearly half of the FORTUNE 200 companies reported having an anti-hedging policy in 2010 proxy filings. However, the hedging policies typically apply to Section 16 officers only, and the Senate bill would appear to cover a broader group. If the compromise bill contains the Senate provisions, the legislation could move companies to extend anti-hedging policies deeper into the organization. Copyright 2010 Aon Hewitt 4 June 7, 2010 / Alert

Special Executive Compensation Rules for Financial Institutions The Senate bill would require the Board of Governors of the Federal Reserve System to issue standards under the Bank Holding Act that would prohibit compensation plans that result in excessive compensation or could lead to material loss to the financial institution. The Federal Reserve is to act in concert with the OCC and FDIC is establishing these standards. Rules are to be promulgated within six months of enactment. The House bill provides that regulators must ban inappropriate or imprudently risky compensation practices at covered financial institutions with assets of at least $1 billion. Institutions would be required to disclose all incentive-based pay elements. The disclosure must enable the SEC to determine if the structures are aligned with sound risk management and do not have a serious adverse impact on financial stability or economic conditions. The SEC could exempt institutions based on size. Regulations are to be issued within nine months of enactment. The Comptroller General is to issue a report within one year of enactment on a study to determine if there is a correlation between compensation structures and excessive risk taking. Corporate Governance Majority Vote In the Senate bill, the SEC would issue rules under which all national stock exchanges would require all listed companies to adopt majority voting standards. In uncontested elections, directors would have to receive a majority of the votes cast to be elected. If the director does not receive a majority, the director would have to tender his or her resignation to the board of directors. The board of directors could either accept the resignation or, on a unanimous vote of the remaining board members, reject the resignation. In the latter case, the board would have to disclose, within 30 days, the reasons why they rejected the resignation and why it is in the best interests of the shareholders. In contested elections, a director must receive plurality of the shares represented at a meeting and entitled to vote to be elected. The SEC is authorized to make exceptions in appropriate situations. The House bill had no provisions on majority vote. Hewitt Comment: An amendment to strip the majority voting provision from the final Senate bill never came up for a vote. Majority voting has gained acceptance as a good governance practice and is utilized by more than two-thirds of S&P 500 companies. Also, in the 2009 proxy season, shareholder proposals calling for a majority vote were very popular. Over 90 majority voting proposals were submitted, with 42 coming to a vote and garnering average support of over 58%. So far in 2010, of the nearly half-dozen proposals that have come to a vote, all but one received majority support, with average support of over 60%. NYSE rules that are in effect for meetings on or after January 1, 2010, prohibit brokers from casting non-directed votes in routine matters, such as an uncontested director election. Since broker non-votes were a reliable, albeit often modest, source of support for existing directors, the lack of this pool of votes where there is majority voting may prove to be problematic. Broker Discretionary Voting The Senate bill would amend the Securities and Exchange Act to prohibit the use of broker discretionary voting in connection with the election of directors, executive compensation issues, or any other significant issue, as defined by the SEC. The Senate bill notes that listing exchanges may permit broker discretionary votes in other matters. The House bill does not address broker discretionary voting. Proxy Access The Senate bill, like the House bill, would grant the SEC authority to issue rules that would permit shareholders to nominate members of the board of directors and have their solicitation materials included in the company s proxy statement. The SEC is to determine what are the appropriate terms and conditions under which proxy access should be granted, based on the best interests of shareholders and protection of investors. Copyright 2010 Aon Hewitt 5 June 7, 2010 / Alert

Hewitt Comment: Unlike other legislative proposals, these bills do not require the SEC to grant proxy access, but only clarify that the SEC is authorized to issue such a rule. The SEC has voted to adopt proxy access, but opened the comment period for additional comments. As of this point, the SEC has not issued a final rule on proxy access. Chair/CEO Structure Disclosure Under the Senate bill, the SEC would be directed, within six months of enactment of the legislation, to require companies to disclose in their proxy whether they have a separate CEO and Chair of the board of directors or if those roles are filled by the same individual. Companies must then explain their reasons for adopting the leadership structure they have chosen. The House bill did not address the issue of leadership structure. Hewitt Comment: The requirements of this provision are already effectively accomplished in the SEC proxy disclosure rules that were issued in December 16, 2009 and effective for proxy filings on or after February 28, 2010. The SEC disclosure rules require a company to disclose in its proxy whether the principal executive officer and board chairman positions are separated or combined. If the roles of principal executive officer and board chairman are combined and a lead independent director is designated, the disclosure must indicate the role the lead independent director plays in the leadership of the board. Finally, the proxy must discuss the reasons why the current board leadership structure is the most appropriate structure for the company. In the December disclosure rules, the SEC indicated that the board leadership disclosure requirement is not intended to influence a company s decision regarding board structure. * * * * * The Executive Compensation Alert is prepared by Aon Hewitt s Executive Compensation Center of Technical Expertise led by Dave Sugar. Questions regarding executive compensation technical issues may be directed to Dave Sugar at 847-295-5000 or dave.sugar@aonhewitt.com. This report is a publication of Aon Hewitt, provides general information for reference purposes only, and should not be construed as legal or accounting advice or a legal or accounting opinion on any specific fact circumstances. The information provided here should be reviewed with appropriate advisors concerning your own situation and any specific questions you may have. http://www.aonhewitt.com Copyright 2010 Aon Hewitt 6 June 7, 2010 / Alert