Era of Fundamental Governance Change

1Weil, Gotshal & Manges LLP

Era of Fundamental Governance Change

￭ Change in balance of state vs. federal regulation of governance

￭ Internal affairs of corporation -- including corporate governance matters – traditionally governed by state law : law of state of incorporation

￭ The Dodd-Frank Act mandates governance structures / practices in areas traditionally regulated only by state law (substantive role of shareholders in nomination process, shareholder voting powers)

Change in balance of board and shareholder power

But Dodd-Frank Act does not alter or eliminate the protections traditionally provided to directors by the business judgment rule


Backdrop to Dodd-Frank Reforms￭ Post-crisis environment highly distrustful of corporate boards and

executives

￭ Ripe for mandated governance reforms, not private ordering

￭ Some proposed reform mandates rejected by Congress

￭ Mandatory majority voting for directors(N.B. – 71% of S&P 500 already have it)

￭ Limits on executive compensation

￭ Mandatory board risk committees for non-financial companies


The Dodd-Frank Act

￭ Focus: Restructuring regulatory framework for U.S. financial system

￭ Also includes provisions that will affect governance of all U.S. public companies, regardless of industry, including:

￭ SEC authority for proxy access

￭ Mandated shareholder advisory votes on certain compensation matters

￭ New limits on broker discretionary voting

￭ New compensation disclosures and compensation committee and adviser independence requirements

￭ Most require further rulemaking by SEC / securities exchanges


Dodd-Frank vs. Sarbanes-Oxley

￭ SOX (and related SEC and stock exchange listing rules) adopted in wake of accounting scandals

￭ Reflects view that empowered independent directors – particularly independent audit committees – are solution to problem of management accountability

￭ Dodd-Frank (and related SEC and stock exchange listing rules) adopted in wake of financial crisis

￭ Reflects view that empowered shareholders are solution to problem of board accountability


Implications of New Environment

• Increase in shareholder power to influence board composition and executive pay

• Increase in power of proxy advisers who advise institutional shareholders on how to vote – or to whom such shareholders delegate vote decisions

• More pressure on boards to accede to wishes of most vocal shareholders – including pressure to conform to rigid ideas about governance and compensation practices

• Expect the 2011 proxy season to be unprecedented in range of matters on which boards will need to elicit shareholder support


Shareholder Engagement

• In new environment, critical need for boards to engage with key shareholders

Board & management need to assess how new Dodd-Frank requirements will likely impact shareholder relations

-- Keep current on implementation rules as they develop-- Consider whether to comment on proposed rules

Consider How to Position for Increased Engagement


Preparation for Engagement

￭ Culture, Attitude & Information

￭ Key Shareholders

￭ Capacity for Shareholder Outreach


Preparation for Engagement

￭ Board Involvement

￭ Governance Community Involvement

￭ Proxy Advisers


Other Actions

• Review director nomination process (including advance notice bylaws)

• Review compensation programs and disclosures, and adjust where necessary

• Determine whether to recommend say-on-pay on 1, 2 or 3 year basis (if permitted under forthcoming SEC implementing rules)

• Review independence of Compensation Committee members and advisers

• Review / revise Compensation Committee charter (as to independence of members, authority over advisers and independence of advisers)


Proxy Access

￭ Dodd-Frank gave SEC express discretionary authority to adopt proxy access rules.

￭ On August 25, SEC adopted rule giving mandatory proxy access to shareholders/ group meeting 3%, 3-year holding period criteria for nominations up to 25% of board; no control purpose or effect (Rule 14a-11)

￭ SEC also amended Rule 14a-8(i)(8) to enable shareholders to bring proposals to amend by-laws re procedures for including shareholder nominees in company proxy statement

￭ Would have become effective in mid-November, but on October 4, SEC stayed effectiveness of both until resolution of court challenge (petition of BRT/U.S. Chamber of Commerce filed in U.S. Court of Appeals for the D.C. Circuit)

￭ Resolution unlikely until late spring


“Say-on-Pay” & “Say-When-on-Pay”

￭ Say-on-Pay

￭ Companies must seek non-binding shareholder vote on compensation package of their named executive officers (“NEOs”) beginning at first meeting held on or after January 22, 2011, as disclosed in company proxy statements.

￭ SEC may create exceptions for small companies if deemed unduly burdensome

￭ Say-When-on-Pay

￭ In year one, companies must seek non-binding shareholder vote on whether “say-on-pay” votes should occur every one, two or three years

￭ Additional votes must occur no less than every six years

￭ Greater pressure on boards to consider shareholder views in compensation

￭ Greater potential for campaigns against Compensation Committee members


“Say-on-Golden-Parachutes”

￭ In connection with any shareholder vote to approve an acquisition, merger or other extraordinary transaction at a meeting on or after January 21, 2011, each person soliciting votes on such a transaction must: (1) disclose any agreements or understandings with senior executive officers (NEOs) regarding any compensation relating to the transaction, along with the total amount; and (2) hold a separate, non-binding shareholder vote on any such agreement or understanding that hasn’t already been submitted to a “say-on-pay” advisory vote of shareholders.

￭ SEC has authority to exempt small companies if deemed unduly burdensome.

￭ SEC expects to publish proposed rules implementing say on pay, frequency and parachutes in late October 2010


Vote Disclosure by Investment Managers

￭ Certain investment managers must report at least annually on how their votes are cast on new executive compensation provisions

￭ Applies to money managers (“13F filers”) exercising investment discretion over U.S. public company equity securities and certain other securities with an aggregate fair market value of at least $100 million

￭ SEC currently expects to issue rules on disclosure details in November-December 2010

￭ Will transparency affect voting decisions? Note that investment companies have been making annual vote disclosures since 2004


New Limits on Broker Discretionary Voting

￭ Last proxy season (2010), broker discretionary voting was barred for the election of directors

￭ New bar on broker discretionary voting on say-on-pay and other executive compensation proposals applicable to the 2011 proxy season

￭ Possible additional bars on other matters as SEC deems “significant”

￭ To be proposed April - July 2011


Whistleblower Incentives & Protections

Bounty Payments: Payments (of between 10% and 30% of amount recovered) to an employee who voluntarily supplies “original information” leading to successful SEC/DOJ enforcement actions

Availability of bounty may reduce incentives to report in-house using internal whistleblower complaint mechanisms

Employee Cause of Action for Retaliation: Dodd-Frank provides that employees subject to retaliation for whistleblowing may sue directly in federal court


Comp Committee & Adviser Independence

Listing rules must require that Compensation Committee:

￭ Satisfy heightened independence standard under SEC rules that must consider receipt of consulting/advisory fees & “affiliate” status (similar to SOX Audit Committee model)

￭ Has authority to appoint, compensate and oversee consultants, independent legal counsel and other committee advisers (and access to funding)

￭ Considers independence factors in hiring consultants/advisers

￭ SEC proposing rules expected November – December 2010


New Compensation Disclosures

￭ Pay vs. Performance: Clear description of relationship between executive compensation paid and the company’s financial performance, taking into account changes in stock price and dividends.

￭ Pay Equity Disclosure

A) The median of the annual total compensation of all the company’s employees except the CEO

B) The annual total compensation of the CEO, and

C) The ratio of (A) to (B)

￭ Proposals on each of the foregoing expected April – July 2011 ￭ Whether Compensation Committee has retained consultant (for

meetings on or after July 21, 2010), whether any conflicts of interest and if so, how addressed ￭ Tied to new independence standards; proposal expected in November –

December 2010


Incentive Compensation Clawback Policies

￭ Listing rules must require company to have & disclose clawback policy

￭ Broader than Sarbanes-Oxley clawback provision (Section 304)

￭ If financial statements restated due to material noncompliance with financial reporting requirements, company must recover from current & former executive officers (not just CEO & CFO) any incentive compensation

￭ Based on the erroneous data

￭ Received during three-year period preceding date on which company becomes required to prepare restatement and

￭ In excess of what would have been paid if calculated under the restatement

SEC implementing proposal expected in April – July 2011


Other Governance-Related Provisions

￭ Disclosure of Permissibility of Hedging by Directors and Employees (SEC proposal expected April – July 2011)

￭ Board Committee Approval of Security-Based Swap Transactions as Condition to Reliance on “End-User” Exception from Mandatory Clearance (SEC proposal expected November – December 2010)

￭ Watch CFTC rulemaking schedule for end-user exception available for swaps regulated by that agency

￭ Disclosure of Board Leadership Structures (required by SEC rule since 2/28/10)


On the Horizon

￭ Some governance provisions limited to financial institutions could inform “best practices” for non-financial companies; has already happened under TARP (link between compensation and excessive risk)

￭ SEC may enhance transparency of securities ownership (i.e., close the 13(d) “10-day window”), short sales and share-lending activities often used to facilitate short-selling and other types of hedging

￭ SEC Proxy “Plumbing” Project – covers a broad array of issues relating to proxy voting by “street-name” holders. Could lead to tighter SEC regulation of proxy advisory firms, given concerns raised by potential ability to sway voting outcomes in era of majority voting and “vote no” campaigns, proxy access (?), say-on-pay, virtual demise of broker discretionary voting, etc.


Expect More Shareholder Proposals in 2011

￭ Separate chair / CEO

￭ Majority voting for directors

￭ Board declassification

￭ Shareholder right to call special meeting

￭ CEO succession

￭ Risk management

￭ Corporate social responsibility:

￭ disclosure re environmental risk

￭ political contributions

Era of Fundamental Governance Change

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