Timetable for governance reform

The massive financial overhaul bill recently signed into law by President Obama has been called the most sweeping set of financial reforms since the Great Depression. Comprising hundreds of pages, the Dodd-Frank Wall Street Reform and Consumer Protection Act is full of mandates that will keep public companies on their toes for months, if not years, to come.

While some of the act’s provisions take immediate effect, most will be phased in, so companies need to determine not only which rules apply, but also when they will apply. The following is a guide to some of the key topics that will affect public company practices.

Parachutes and say on pay
The say-on-pay component will require companies to give shareholders a chance to voice their approval on a public company’s disclosures of executive compensation, yet the law doesn’t require anything of companies if shareholders show their displeasure.

Critics say it will be unclear what, exactly, a ‘no’ vote would be opposing: the specific disclosures, the lack of transparency about executive compensation in general, or the amount of the compensation itself? Proponents argue, however, that the rule will encourage boards to consider shareholder opinions when making decisions about how much to pay executives.

These votes must be included in proxy statements for annual meetings from six months after the law’s signing (that is, starting in January 2011). Company boards should analyze their executive compensation packages now and revisit their disclosures with an eye toward anticipating elements that may be controversial.

Similar voting rules will apply to golden parachute payments for executives in connection with M&A deals. Companies looking at potential M&A transactions may want to review employment, severance and other compensation terms that could be triggered by a transaction to determine whether any potential golden parachute payments might cause discord among their shareholder base.

Companies will also be required to provide the ratio of their CEOs’ total compensation to median employee total compensation, which will be calculated under the same method currently provided in proxy statements for executive officers.

This will be a potentially daunting data-gathering exercise for companies with many employees, so companies should begin formulating a process now to ensure they will be able to run the new calculations in good time.

Company clawback provision
Under the act, the SEC is required to instruct national securities exchanges such as the NYSE and NASDAQ to de-list companies that have not implemented and disclosed a clawback policy, which allows a company to take back any excess executive incentives and bonuses tied to restated financials.

There is no timetable as yet for implementation. Large public companies that already have some form of clawback policy will need to review it for compliance with the more precise requirements outlined in the act. Firms without clawback policies should begin the drafting process now.

Proxy access
Under current rules, shareholders who want to nominate someone to serve on a board of directors must file their own proxy statements – at considerable expense. A growing shareholder democracy movement has long lobbied for investors to be able to nominate their own candidates without incurring the costs themselves.

Thanks to Dodd-Frank, the SEC has been given express authority to adopt rules relating to the inclusion of shareholders’ nominees in a company’s proxy materials. Although the SEC struggled over the last decade to find a balance between shareholder interests and boards of directors’ authority, following Dodd-Frank’s enactment the commission moved swiftly. New rules to be effective later this fall will start allowing inclusion in company proxy materials of nominees from shareholders who hold at least 3 percent and have held their shares for three years.

In preparation, companies should analyze their shareholder base and strive to maintain open dialogue with major holders. Healthy IR could go a long way toward allaying adverse shareholder activism.

Compensation committee independence
Dodd-Frank will require national stock exchanges to de-list non-exempt companies whose compensation committees fail to meet certain heightened independence requirements. New independence rules – still to be developed by the SEC – will take into account consulting, advisory and other fees paid to compensation committee members. The rules will also account for whether members are affiliates of the company.

The new rules will mandate that compensation committees be authorized to retain and manage compensation consultants, legal counsel and other advisers only after evaluating their independence based upon various ‘competitively neutral’ factors to be determined by the SEC, such as other services performed for the company, fees received from the company, policies and procedures designed to prevent conflicts of interest, business or personal relationships between the adviser and compensation committee members, and the amount of company stock owned by the adviser.

Disclosures relating to this rule will be required to be included in proxy statements issued after the act’s one-year anniversary, which means most firms won’t be subject to the rule until the 2012 proxy season. Changes in practices or committee members can require lengthy lead times, however, so listed companies should begin analyzing these issues now.