Finding your way in the days of say-on-pay: tips for your 2011 proxy materials

Corporate Governance Alert


Companies subject to the SEC’s proxy solicitation rules are required to submit for a non-binding shareholder vote a separate resolution to approve the compensation of executives, as disclosed pursuant to Item 402 of Regulation S-K, not less frequently than once every three years (or SOP proposal). In addition, at least once every six years, those companies must submit for a non-binding shareholder vote a separate resolution to determine whether the shareholder vote regarding executive compensation (often called the Frequency Proposal) will occur every one, two or three years. These requirements apply to meetings of shareholders occurring after January 21, 2011.

In mid-October, the SEC proposed rules implementing these requirements, as we discussed in our October 26 Alert. There are, however, many open issues regarding the presentation, wording and description of SOP proposals.

In this article, based on our review of SOP proposals presented by companies in the financial services industry and other companies where management included such a proposal in its proxy materials, we highlight certain issues companies and their boards should consider as they plan the contents of their 2011 proxy materials.

Emphasize the positive aspects of your executive compensation plan

In our review, we observed that most companies include a paragraph or two discussing the company’s executive compensation design and philosophy in the section of the proxy statement describing the SOP proposal. Companies should recognize that this section provides an opportunity to convince shareholders to vote for the SOP proposal.

The following is a list of specific investor-friendly compensation decisions and practices that, if applicable, could be highlighted in the introduction to the compensation disclosure:

  • compensation that is incentive-based, is at risk or otherwise uses a pay-for-performance structure, sometimes profiling specific decisions to award or not award certain compensation to executive offers for the prior year
  • a decision to not enter into employment or severance agreements
  • limits on post-employment benefits
  • elimination of or restrictions on perquisites and tax gross-up payments
  • adoption of policies requiring compensation consultant independence
  • adoption of executive stock ownership requirements
  • adoption of clawback policies to recover incentive compensation based on financial performance that is later restated
  • intentional decisions to pay below peer companies
  • long-term vesting arrangements on equity compensation, and
  • profiling of good governance practices used by compensation committees

If your company has a pay-for-performance structure, consider summarizing your company’s performance and, if helpful and relevant, include cross-references to the MD&A section, which goes into additional details about the performance of the company. In addition, you might include a short summary about the relationship between pay practices and financial performance. Such a summary could assist ISS and other governance advisors in evaluating your company’s executive compensation policies quickly and could make it more likely that the factors you consider important will be taken into consideration by such entities in evaluating your executive compensation policies.

What should the SOP proposal include?

Proposed Rule 14a-21(a) requires companies to provide a separate shareholder advisory vote to approve the compensation of executives. The advisory vote is to approve the compensation of named executive officers, such as compensation that is disclosed pursuant to Item 402 of Regulation S-K, including the CD&A, the compensation tables and other narrative executive compensation disclosures required by Item 402.

The SEC has not proposed any specific language and is soliciting comments on whether specific language should be mandated. The comment period for the proposed SEC rules expires on November 18, 2010 and the SEC is expected to publish the final rules shortly thereafter. In advance of the final rules, companies should consider the following tips in drafting the language of a SOP proposal:

  • Limit the resolution to “the compensation of executives.” Thus, the proposal could read “approve the compensation of executives disclosed pursuant to Item 402 of Regulation S-K.” In contrast, a proposal that seeks approval of compensation paid to “named executive officers” (rather than “executives”) may raise questions about whether shareholders voting for the proposal have ratified the company’s broad design of its compensation program, employment, severance and change-of control-agreements for executives other than the named executive officers, the company’s compensation policies and practices as they relate to risk management or other disclosures that bear on compensation to executives generally rather than NEOs specifically. In addition, we recommend that any SOP proposals be narrowly tailored to only address Rule 14a-21(a)’s requirements. For example, if a SOP proposal inadvertently also addresses ratification of compensation paid to directors, it is very likely that the SEC Staff may issue a comment that the company unbundle its proposals pursuant to Rule 14a-4(a)(3), which requires a company to identify in its form of proxy each separate matter intended to be acted upon by a company’s shareholders.
  • The resolution should not expressly address compensation disclosures other than those required by Item 402 of Regulation S-K. A generalized request that shareholders ratify compensation “as disclosed pursuant to the SEC’s compensation disclosure rules” (rather than a reference to Item 402) may also be acceptable, although this wording could raise questions about what exactly the company is asking its shareholders to ratify. We note that specifically asking shareholders to ratify the Compensation Committee Report required by Item 407 of Regulation S-K as part of the SOP proposal (which some companies have done voluntarily) might lead to unbundling problems like those referenced above.
  • Explain what the company intends to do with the results of the vote. Most companies have reminded shareholders that their vote is advisory and non-binding on the company but have stated in general terms that they will consider the results and take them into account in future compensation decisions. A few companies have reminded shareholders that they have other avenues besides the “up or down” say-on-pay vote for communicating to the company more particularized views about executive compensation, such as by writing or emailing the company’s Investor Relations personnel or independent directors. A few companies have taken a further step and disclosed that they will consult directly with shareholders to better understand concerns driving significant negative votes.
  • Placement of say-on-pay in proxy statement. Most companies have simply placed their SOP proposal in the sequence immediately following other management proposals. However, in light of the new emphasis in the Dodd-Frank Act and from the SEC on SOP, we expect some companies will present the SOP proposal as close as possible to the CD&A and other compensation disclosures.

Other issues to keep in mind

In addition to the issues noted above, companies should keep in mind the following issues related to the SOP and Frequency Proposals as they prepare for the 2011 proxy season:

  • Frequency of SOP votes. As discussed briefly above and in our earlier alert, a company’s board of directors is expected to make a recommendation on the frequency of the SOP vote. The disclosure will also have to clarify that the shareholders are being asked to vote on the four prescribed choices (every one, two or three years, or abstention), and not on approval or disapproval of the board’s recommendation. As of now, there are no “best practices” describing how often a company should present an SOP vote is its proxy materials, and a particular company’s approach will depend upon its own unique circumstances. For example, we understand that many large mutual funds support biennial and triennial approaches. However, certain institutional shareholders, such as Walden Asset Management, the AFL-CIO and TIAA-CREF, have indicated a preference for annual SOP votes. We also understand that ISS is expected to adopt a new policy to vote in favor of companies providing for annual SOP proposals. Ultimately, companies will have to weigh the governance benefits of receiving annual input from shareholders about executive compensation policies, and the fact that compensation changes can appear more dramatic when the shareholders are reviewing these only every two or three years with the benefits of the biennial or triennial approaches (such as reducing the potential disruption for shareholder no votes and having shareholder input over a broader time to permit evolution in compensation policies) in deciding the frequency they wish to recommend.
  • Proposed amendment to Item 402(b) of Regulation S-K. This amendment requires disclosure of how a company’s compensation policies and decisions are affected by prior SOP votes. If this amendment is adopted, companies will have to disclose in the CD&A whether and, if so, how they have considered the results of prior mandatory SOP votes in administering their compensation policies.
  • Proposed new Item 24 to Schedule 14A. New Items 24 will require companies to explain the general effect of the SOP vote and the vote on the Frequency Proposal.
  • Proposed disclosure in Form 10-Q or Form 10-K. Under the proposed rules, companies will be required to disclose, in their Form 10-Q or Form 10-K covering the period in which the advisory vote is taken, their decision regarding how frequently the company expects to conduct SOP votes in light of the results of the vote on the Frequency Proposal.

The value of a thoughtful presentation on executive compensation

There is a surprising variety among the existing SOP precedents. While much can be gleaned from these disclosures, their value should be considered in light of your particular compensation polices, financial results, other disclosures and shareholder base. Most US public companies have not included an SOP or Frequency Proposal in their proxy materials, and each of these proposals is likely to draw increased attention to the company’s executive compensation disclosure. As has been widely reported, SOP proposals at three US public companies failed in the 2010 proxy season.

Beyond the SOP and Frequency Proposals, of course it is also critical to explain accurately your compensation policies and compensation decisions. Companies should spend time reviewing their CD&A to be sure it tells shareholders the full story about compensation decisions. Governance practices should be reviewed to be sure that the Compensation Committee is using best practices throughout the year. It will also undoubtedly help in this changing landscape to consult with counsel, proxy solicitors and the primary proxy advisory services and to consider any current dialogue with the shareholders on the topic of executive compensation before going out with your inaugural SOP and Frequency proposals in 2011. Spending time to thoughtfully develop your SOP and Frequency Proposals in light of your particular policies and decisions and the input of these professionals is likely to increase the chances of obtaining a positive result for your company.

For more information, please contact:

Andrew D. Ledbetter

Sanjay M. Shirodkar

See our reports on breaking developments around Dodd-Frank here.