Inside Restoring American Financial Stability Act of 2009 Introduction Executive Say on Pay Golden Parachutes Committee Independence Consultant and Advisor Independence Standards Enhanced Disclosures Clawbacks Hedging Special Financial Institutions Rules Corporate Governance Majority Vote Proxy Access Alert 2009-10 Senator Dodd to Introduce Restoring American Financial Stability Act of 2009 On November 11, 2009 Senator Christopher Dodd (D-CT) unveiled his 1,136 page Restoring American Financial Stability Act of 2009 ( RAFSA ). The bill, if enacted in its present form, would create new regulatory bodies designed to protect consumers and regulate financial institutions, increase the authority of existing agencies, create new offices within existing agencies, provide for self-funding of the SEC, and make substantial changes in executive compensation and corporate governance. Senator Dodd circulated the draft legislation asking for comments and proposed amendments before the bill is formally introduced. As the bill was being prepared for markup, Senator Dodd announced a delay. There is no indication from the Senator when the bill will be formally introduced or whether there will be major changes to the draft version. This Executive Alert focuses on the executive compensation and corporate governance sections of the draft legislation. We believe it is important to notify our readers of these potential legislative changes, even at this very early stage. Experience from past legislative efforts has shown that the final executive compensation and corporate governance provisions often tend to be comparable to those initially proposed. Executive Say on Pay Public companies would be required to provide shareholders with a nonbinding advisory vote on their executive compensation proxy disclosure, a say on pay provision. This provision would become effective for shareholder meetings occurring one year after passage of the bill. Hewitt Comment: The concept of say on pay is widely popular with the voting public, and this provision is similar to others that have been previously proposed A number of companies have already voluntarily provided management say on pay proposals at their annual meetings. Additionally, financial institutions that received TARP funds are required to give shareholders the right to vote on executive compensation disclosures at their annual meetings. The interesting lesson from this past proxy season is all executive pay proposals put to a shareholder vote passed. For the approximately 15 non-tarp companies who voluntarily provided say on pay proposals, average support was 83%. For TARP companies that were required to provide a say on pay resolution, average support was 89%. Chair/CEO Structure Classified Boards Copyright 2009 Aon Hewitt 1 November 24, 2009 / Alert
Golden Parachutes Any compensation arrangement payable to the CEO upon the acquisition, merger, consolidation, sale, or other disposition of the company would be subject to shareholder vote, unless it was previously approved by the shareholders. Any such shareholder vote would not be binding nor would it create a fiduciary duty on the directors. This provision would be effective for shareholder meetings occurring one year after the law is enacted. Hewitt Comment: If RAFSA was enacted as drafted, we would not expect companies to solicit a vote on this matter prior to a transaction that would trigger the shareholder vote requirement. There were only 11 shareholder proposals this last proxy season calling for a shareholder vote on golden parachutes. Of the four that came to a vote, none received majority support, and the average support was only 36%. Committee Independence The SEC would be directed to issue rules requiring all national stock exchanges to amend their listing standards to require all listed companies to maintain an independent compensation committee. The SEC would be authorized to make appropriate exceptions. These rules would have to be issued within 360 days following enactment of the legislation. (This 360-day deadline applies to other rules the SEC must issue as described 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. Consultant and Advisor Independence Standards The SEC would be required to adopt independence requirements for compensation consultants, legal counsel, or other advisors. It would be up to the SEC to adopt an appropriate definition of independence. 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. The SEC would also be directed to undertake a study of the use of compensation consultants and the effect of the use of the consultants on the performance of covered companies. The SEC would have to submit its report to Congress within three to five years after enactment of the legislation. Hewitt Comment: This section of the legislative proposal reflects the view of many in Washington that the compensation committees need to be more assertive in maintaining independent oversight of the executive compensation programs. Enhanced Disclosures 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 fiveyear period compared to the financial performance of the company or the return to investors during that same period. Hewitt Comment: The vagueness of the proposed legislation raises many questions as to how the SEC would implement the new requirement. Given the fluid nature of the list of officers that are named in the proxy along with the recent changes in what is disclosed in the Summary Table, we think the SEC will find it challenging to establish rules for compensation paid to executives in the last five years. Copyright 2009 Aon Hewitt 2 November 24, 2009 / Alert
Clawbacks 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. The clawback policy would apply to all executive officers, current and former executives, 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 payable under the restatement. Hewitt Comment: Our data shows that 61% 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 guilty of malfeasance. The Dodd 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 Public companies would be required to disclose if their employees are eligible to purchase financial instruments to hedge or offset any decrease in the market value of equity that is part of the employees compensation package. Hewitt Comment: Our data shows that 42% of the FORTUNE 200 companies reported having an antihedging policy in 2009 proxy filings. This was an increase over the 30% reporting anti-hedging policies in 2008. However, the hedging policies typically apply to Section 16 officers only, and the Dodd bill would appear to cover a broader group. If passed in its present form, the legislation could move companies to extending anti-hedging policies deeper into the organization. Special Executive Rules for Financial Institutions A new agency, the Financial Institutions Regulatory Administration (FIRA) would be established under the bill and would be required to issue standards that would prohibit compensation plans that result in excessive compensation or could lead to material loss to the financial institution. The bill would also allow appropriate federal regulators to impose higher capital standards at financial institutions with compensation practices that, in the opinion of the federal regulator, pose a risk to the institution. Finally, appropriate federal regulators would be instructed to prohibit covered financial institutions from paying executive compensation that is excessive or could lead to material loss to the institution. Corporate Governance Majority Vote The SEC would issue rules under which all national stock exchanges would have to 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 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. Copyright 2009 Aon Hewitt 3 November 24, 2009 / Alert
Hewitt Comment: Majority voting has gained acceptance as a good governance practice, and is utilized by over 50% 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%. 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. Proxy Access Within six months after enactment of the bill, the SEC would be required 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. Hewitt Comment: The SEC s own proxy access proposals as well as another legislative proposal by Senator Schumer would require a minimum ownership interest, generally from 1% to 5%, depending on the size of the company, before proxy access was granted. The Dodd proposal leaves this totally in the purview of the SEC. Chair/CEO Structure Disclosure 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. Hewitt Comment: Like the previous provision, this approach mirrors one already proposed by the SEC. However, it is different than Senator Schumer s proposed legislation which would mandate different individuals for the CEO and Chair positions. Our analysis of the proxy filings of the FORTUNE 200, showed that in 75% of companies, the CEO also served as chair. Of the remaining 25% of companies that reported a separate chair, in 70% of the cases, the chair was the former CEO or other related party. At the same time, there were 47 shareholder proposals calling for an independent/separate chair in 2009. Of the 27 that came to a vote, only two received majority support. Average support was 34%. Staggered (Classified) Boards Require Shareholder Approval The SEC would be directed to issue rules requiring all national stock exchanges to amend their listing standards to require shareholder approval for a listed company to maintain a classified board. The proposal provides for a transition period to allow classified boards to come into compliance. Hewitt Comment: The Schumer bill also called for the annual election of directors. There is a definite trend toward annual elections for all directors, but there are still a significant number of companies with classified boards. In the 2009 proxy season, there were 78 proposals calling for a repeal of a classified board. Of the 45 that came to a vote, 28 received majority support. Average support for all proposals was 64%. Copyright 2009 Aon Hewitt 4 November 24, 2009 / Alert
* * * * * The Executive Alert is prepared by Aon Hewitt s Executive 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 2009 Aon Hewitt 5 November 24, 2009 / Alert