The Dodd-Frank Wall Street Reform Act and the Preemption of Delaware Law (Say on Pay, Part 1)

We are examining the instances of preemption of Delaware law by the Dodd-Frank Wall Street Reform Act.  Another area of preemption concerns say on pay. 

Delaware law defines a number of mandatory matters that must be submitted to shareholders.  These include the sale of the business (mergers, dissolution, sale of all or substantially all of the assets), amendments to the charter, and the election of directors. 

We can now add another, gratis of Dodd-Frank:  Executive compensation or so called "say on pay"; (Section 14A of the Exchange Act, 15 USC 78n-A).  The provision, as we will discuss below, is broad.  Unlike other requirements in the DFA, this one applies not just to listed companies but to all companies subject to the proxy rules (companies registered under Section 12(g) with 500 shareholders of record and $10 million in assets).  It represents the first time on a comprehensive basis that shareholders have been given the specific authority to vote on particular matters.

Section 951 of the DFA adds Section 14A to the Exchange Act.  The provision provides that "[n]ot less frequently than once every 3 years shareholders "shall have the right" to approve in "a separate resolution" the compensation of those executives disclosed under Item 402 of Regulation S-K.  The frequency of the resolution (whether every one, two or three years) will be determined by shareholders, with a vote on the issue taken at least every six years.  The section also requires, in some instances, that shareholders be given the right to approve golden parachutes. 

The Conference Report Summary states that these provisions would give “shareholders a powerful opportunity to hold accountable executives of the companies they own, and a chance to disapprove where they see the kind of misguided incentive schemes that threatened individual companies and in turn the broader economy.”

The preemptive effects are clear.  Under Delaware law, at least one Vice Chancellor has noted that say on pay arguably conflicts with Delaware law.  See Leo E. Strine, Jr., Breaking the Corporate Governance Logjam in Washington: Some Constructive Thoughts on a Responsible Path Forward, 63 Bus. Law. 1079 (2008)("Although the issue has not been resolved in Delaware, distinguished scholars have suggested that a bylaw requiring stockholder approval of executive compensation contracts would be at greater risk of invalidation than a bylaw governing the conduct of director elections. n82 Setting the compensation for top executives has long been considered a core managerial function of a board of directors.").  Perhaps but resolution doesn't matter.   Federal law preempts any conflicting state law provisions.  

As we will discuss in the next post, the preemptive effect of say on pay may be much broader than simply allowing shareholders to vote on compensation packages.  It may create a federal obligation to solict proxies.  

The Dodd-Frank Wall Street Reform Act and a short Summary of the legislation are posted online.