The Dodd-Frank Wall Street Reform Act and the Preemption of Delaware Law (Say on Pay, Part 2)

There are a couple of things about mandatory say on pay that are potentially quite far reaching.  First, the provision largely leaves to the SEC under its authority in Item 402 to determine exactly what shareholders will be asked to approve.  Currently Item 402 requires disclosure of the compensation of the CEO, CFO and three highest paid executive officers.  See Item 402(a)(3) of Regulation S-K.  To the extent that the SEC wants to expand the disclosure to other officers, it could and shareholders would have a right to vote on that compensation as well.  Moreover, while the provision requires "a separate  resolution" on compensation, there is no reason why the SEC couldn't require multiple separate resolutions for particular executives or category of executives.

Second, and more profoundly, the provision may create a federal obligation to solicit proxies.  The provision expressly requires a vote "[n]ot less frequently than once every 3 years."  This seems to impose a federal obligation to solicit proxies, a significant change in the law.  Currently,  the solicitation of proxies is not required under state law.  While it is required under the rules of the stock exchange, see Rule 402.04(a)(“Actively operating companies are required to solicit proxies for all meetings of shareholders. “), Nasdaq Listint Rule 5620(b), non-exchange traded public companies can avoid the requirement (although they must still distribute an Information Statement under Section 14(c) of the Exchange Act).  See 15 USC 78n(c).  

To the extent proxies must be solicited on a compensation resolution, the proxy rules would likely require the company to solicit proxies on all other matters being voted on at the meeting.  See Rule 14a-4, 17 CFR 240.14a-4 (The proxy card "[s]hall identify clearly and impartially each separate matter intended to be acted upon, whether or not related to or conditioned on the approval of other matters, and whether proposed by the registrant or by security holders.").   In short, say on pay establishes a federal obligation of all companies to submit proxies (other than those exempted in the statute, such as controlling companies). 

Finally, we note that the provision provides that say on pay is non-binding and that shareholder action does not create any additional fiduciary obligations.  Because fiduciary duties are a matter of state law, there is nothing in the statute that prevents states from taking into account the requirements of say on pay in determining a board’s fiduciary obligations.  While directors can reject any advisory vote disapproving executive compensation, the rejection, like all board matters, must be consistent with the board’s fiduciary obligations.  As a result, the language in Section 14A notwithstanding, boards will find their fiduciary obligations triggered when they react to shareholder disapproval of executive compensation.            

The Dodd-Frank Wall Street Reform Act and a short Summary of the legislation are posted online.  We have included the "say on pay" provision below.

SEC. 951. SHAREHOLDER VOTE ON EXECUTIVE COMPENSATION DISCLOSURES.

The Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.) is amended by inserting after section 14 (15 7 U.S.C. 78n) the following:

SEC. 14A. SHAREHOLDER APPROVAL OF EXECUTIVE COMPENSATION.

(a) SEPARATE RESOLUTION REQUIRED.—

(1) IN GENERAL.—Not less frequently than once every 3 years, a proxy or consent or authorization for an annual or other meeting of the shareholders for which the proxy solicitation rules of the Commission require compensation disclosure shall include a separate resolution subject to shareholder vote to approve the compensation of executives, as disclosed pursuant to section 229.402 of title 17, Code of Federal Regulations, or any successor thereto.

(2) FREQUENCY OF VOTE.—Not less frequently than once every 6 years, a proxy or consent

or authorization for an annual or other meeting of the shareholders for which the proxy solicitation rules of the Commission require compensation disclosure shall include a separate resolution subject to shareholder vote to determine whether votes on the resolutions required under paragraph (1) will occur every 1, 2, or 3 years.

(3) EFFECTIVE DATE.—The proxy or consent or authorization for the first annual or other meeting of the shareholders occurring after the end of the 6-month period beginning on the date of enactment of this section shall include—

(A) the resolution described in paragraph (1); and (B) a separate resolution subject to shareholder vote to determine whether votes on the resolutions required under paragraph (1) will occur every 1, 2, or 3 years.

(b) SHAREHOLDER APPROVAL OF GOLDEN PARACHUTE COMPENSATION.—

(1) DISCLOSURE.—

In any proxy or consent solicitation material (the solicitation of which is subject to the rules of the Commission pursuant to subsection (a)) for a meeting of the shareholders occurring after the end of the 6-month period beginning on the date of enactment of this section, at which shareholders are asked to approve an acquisition, merger, consolidation, or proposed sale or other disposition of all or substantially all the assets of an issuer, the person making such solicitation shall disclose in the proxy or consent solicitation material, in a clear and simple form in accordance with regulations to be promulgated by the Commission, any agreements or understandings that such person has with any named executive officers of such issuer (or of the acquiring issuer, if such issuer is not the acquiring issuer) concerning any type of compensation (whether present, deferred, or contingent) that is based on or otherwise relates to the acquisition,  merger, consolidation, sale, or other disposition of all or substantially all of the assets of the issuer and the aggregate total of all such compensation that may (and the conditions upon which it may) be paid or become payable to or on behalf of such executive officer.

(2) SHAREHOLDER APPROVAL.—Any proxy or consent or authorization relating to the proxy or consent solicitation material containing the disclosure required by paragraph (1) shall include a separate resolution subject to shareholder vote to approve such agreements or understandings and compensation as disclosed, unless such agreements or understandings have been subject to a shareholder vote under subsection (a).

(c) RULE OF CONSTRUCTION.—The shareholder vote referred to in subsections (a) and (b) shall not be binding on the issuer or the board of directors of an issuer, and may not be construed—

(1) as overruling a decision by such issuer or board of directors;

(2) to create or imply any change to the fiduciary duties of such issuer or board of directors;

(3) to create or imply any additional fiduciary duties for such issuer or board of directors; or

(4) to restrict or limit the ability of shareholders to make proposals for inclusion in proxy materials related to executive compensation.

(d) DISCLOSURE OF VOTES.—Every institutional investment manager subject to section 13(f) shall report at least annually how it voted on any shareholder vote pursuant to subsections (a) and (b), unless such vote is otherwise required to be reported publicly by rule or regulation of the Commission.

(e) EXEMPTION.—The Commission may, by rule or order, exempt an issuer or class of issuers from the requirement under subsection (a) or (b). In determining whether to make an exemption under this subsection, the Commission shall take into account, among other considerations, whether the requirements under subsections (a) and (b) disproportionately burdens small issuers.