Impacts of the Dodd-Frank Wall Street Consumer Protection Bill* of 2010 on Executive Compensation

By Jim McMaster

The Dodd-Frank Wall Street Consumer Protection Bill* of 2010 ("Bill"), sponsored in the House by Rep. Barney Frank, and in the Senate, by Senator Christopher Dodd was passed by the House on June 30 and by the Senate on July 15. On July 21, 2010, it was signed into law by President Obama. The Act touches a vast array of financial issues. Below are some of the executive compensation topics it addresses.

1. Say on Pay
Section 951 of the Bill amends the Securities and Exchange Act of 1934 (the "Exchange Act") to require shareholder votes on executive compensation not less frequently than every three years. A number of public corporations have already adopted these so-called "say on pay" votes, but the new legislation requires that all public companies hold them. Institutional investors must also report at least annually how they have voted on such votes.

Additionally, a second shareholder vote - addressing whether the vote on compensation shall be every one, two or three years - is required not less frequently than every six years.
The Bill also adds an additional disclosure and vote requirement for any special compensation (or "golden parachute") to be paid in connection with an acquisition, merger, consolidation or proposed sale or other disposition requiring shareholders' approval. This vote would be separate from the vote approving the transaction.
It is important to note that these votes will be nonbinding on the board and, in fact, the bill makes it clear that the vote cannot be construed as overruling a decision by the company or its board or as creating or implying any additional fiduciary duties of the company or its directors. This is in part, because, with the exception of the new information required on median CEO and employee compensation described below, all the information provided to shareholders comes from the existing disclosure framework which is based on retrospective reporting. Already the shareholders of some companies that previously adopted "say on pay" votes have failed to approve executive pay. Commentators are watching closely to see whether this leads to litigation.
Section 971 of the Bill also opens up access to the proxy process which is expected to affect "say on pay" issues.
2. Compensation Committee Procedures
Section 952 of the Bill requires the SEC to direct national security exchanges and associations to prohibit any listing of securities unless the issuer complies with new rules regarding compensation committees. The Bill amends Section 10B of the Exchange Act by setting out a number of procedures and safeguards that must be followed to assure independence when retaining compensation consultants and requiring additional safeguards to ensure that compensation committees be made up of independent directors. Additionally, companies will be required to fund the compensation committee's retention of independent legal counsel (counsel other than the corporation's regular counsel) in furtherance of meeting its responsibilities to assure independence.

Furthermore, the compensation committee must have the authority to make the decision to retain compensation consultants in its sole discretion, and it must be directly responsible for the appointment, compensation and oversight of compensation consultants. The retention of such consultants must also be disclosed along with any conflicts of interest raised by their retention.

3. Additional Metrics

Public companies are already required to report extensive compensation information regarding their highest-paid executives pursuant to the Exchange Act. Section 953 of the Bill amends disclosure regulations to require the disclosure of additional metrics in a public company's proxy or consent solicitation materials for its annual meeting. These include: the median annual total compensation of all employees other than the chief executive officer, the annual total compensation of the chief executive officer, and the ratio of the two.

Additionally, Section 953 of the Bill amends the Exchange Act by inserting a provision requiring public companies to include, in any proxy or consent solicitation material for shareholder annual meetings, a clear description of the relationship between executive compensation paid and financial performance of the company, taking into account any change in the value of the shares of stock and dividends of the issuer.

4. Recovery of Erroneously Awarded Compensation ("Clawback")

Section 954 of the Bill amends Section 10 of the Exchange Act by adding a new provision requiring each reporting company to recover from its executives any incentive-based compensation paid during the three-year period preceding the date of any required restatement of its financials, when the compensation is based on the erroneous financial reports being restated.

5. Employee and Director Hedging

Section 955 of the Bill amends Section 14 of the Exchange Act by inserting a provision that requires public companies to disclose, in any proxy or consent solicitation materials for shareholder annual meetings, whether any employee or member of the board, or their designees, are permitted to purchase financial investments that are hedges against decreases in the price of the company's stock held by such individual.

6. Excessive Compensation by Holding Companies of Depository Institutions

Section 956 of the Bill amends the Bank Holding Company Act of 1956 to require the Board of Governors, in conjunction with the Comptroller of the Currency and the FDIC, to establish standards prohibiting, as unsound banking practices, compensation plans of bank holding companies that pay "excessive compensation, fees or benefits or could lead to material financial loss to the bank holding company."

7. Voting by Brokers

Finally, Section 957 of the Bill amends Section 6 of the Exchange Act by requiring national exchanges to prohibit brokers from granting a proxy to vote a beneficial owner's securities unless the beneficial owner has instructed the broker to vote the proxy in accordance with the owner's voting instructions.

*Formerly known as the "Restoring American Financial Stability Act."

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