Golden Parachute Compensation Arrangements

The Securities and Exchange Commission (SEC) recently issued its final rule implementing the requirements under the Dodd-Frank Act relating to approval of executive compensation and "golden parachute" compensation arrangements by shareholders. This rule applies to all issuers (public companies) who are subject to the executive compensation disclosure requirements under Item 402 of Regulation S-K (i.e., CD&A and compensation tables and other narrative disclosures).

Companies that qualify as a "smaller reporting company" (i.e., public float of less than $75 million as of the last day business day of the second fiscal quarter within the company's fiscal year immediately prior to January 21, 2011), are exempt from certain requirements under the final rule until applicable meetings on or after January 21, 2013.

Shareholder approval of Executive Compensation (say-on-pay)

What is required?

Under the final rule, all public companies subject to the Act are required to provide for a separate shareholder advisory vote (i.e., say-on-pay) in proxy statements to approve the compensation of named executive officers (NEOs). This vote applies in general to all NEO compensation disclosed in the proxy statement under the CD&A, compensation tables and narrative discussion. The advisory vote does not apply to director compensation and does not change the scaled compensation disclosure requirements applied to smaller reporting companies (i.e., eliminates CD&A and certain other tables).

When is the vote required?

The shareholder advisory vote to approve executive compensation is required only when proxies are solicited for an annual or other meeting at which directors will be elected and for which executive compensation disclosure is required. The first such meeting occurring after January 21, 2011, must provide for this vote. This vote is required at least once every three calendar years. For example, if the
first vote occurs with respect to an annual meeting on April 1, 2011, the next vote must be provided for at the annual meeting held in 2014. Smaller reporting companies are not subject to the voting requirement until the first applicable annual meeting after January 21, 2013.

How is the vote structured?

The final rule does not require companies to use any specific language or form of resolution to be voted on. However, it must be clear that the separate vote is to approve the compensation of executives, as disclosed pursuant to Item 402 of Regulation SK. The following non-exclusive example of a resolution that meets the
requirement is provided: "RESOLVED, that the compensation paid to the company's named executive officers, as disclosed pursuant to Item 402 of Regulation S-K, including the Compensation Discussion and Analysis, compensation tables and narrative discussion is APPROVED"

What is the effect of the vote?

This shareholder vote on executive compensation is not binding on the company or its board of directors. The non-binding nature of the vote must be explained in the proxy statement providing the approval resolution.

What are other requirements with respect to the say-on-pay vote?

Companies must disclose in their proxy materials the current frequency of the say-on-pay vote and when the next vote will occur. Within the CD&A, the company must address whether, and if so, how their compensation policies and decisions have taken into account the results of the most recent shareholder advisory vote on executive compensation. Smaller reporting companies while not required to include the CD&A would be required to disclose any material factors necessary to understanding their tabular disclosures including, if relevant, prior say-on-pay votes.

How does this voting requirement impact companies with outstanding debt obligations under TARP?

The annual shareholder advisory vote on executive compensation as required under the Economic Stabilization Act of 2008 for those financial institutions with outstanding indebtedness under the TARP satisfies the say-on-pay vote requirement. Upon repayment of the debt, the company would be required to include an advisory vote resolution in the proxy for the first applicable annual meeting after debt repayment.

Comment:
Companies and their boards will need to make the case in the proxy statement for a favorable say-on-pay vote by demonstrating, in a clear and simple manner, that their executive compensation is aligned with shareholder interests. In determining their voting recommendations, shareholder advisory firms will take into account among other factors:

• Strength of alignment between pay and performance;

• Existence of challenging goals tied to performance metrics that drive shareholder value;

• Level of harmful risk potentially created by incentive compensation plans for executives;

• Inequity in pay between the CEO and other executive officers;

• Existence of poor pay practices (e.g., excessive severance payments, perquisites and personal benefits); and

•Clarity and sufficiency of disclosure.

Making the case may require restructuring the proxy presentation by adding a high level summary in advance of the CD&A, utilizing simple graphs and charts, and by reducing unnecessary narrative that merely explains the operation of the pay plans.

Shareholder Approval of Frequency of Shareholder Votes on Executive Compensation

What is required?

A separate shareholder advisory vote is required regarding the frequency of the say-on-pay vote referenced above. The frequency vote in the proxy statement must provide four choices: once every 1, 2, 3 years, or abstain. Smaller reporting companies are exempt from this requirement until applicable annual meetings after January 21, 2013.

When is the vote required?

The first say-on-pay frequency vote by shareholders is required in the proxy statement for the first annual meeting occurring on or after January 21, 2011, at which directors are elected. Following this initial vote, a shareholder frequency vote is required no less frequently than once during the six calendar years following each previous vote. Newly public companies must include this frequency vote in the company's first annual meeting after the initial public offering. The proxy statement must disclose the current frequency of this vote and when the next frequency vote is scheduled.

How is the vote structured?

The final rule does not provide a specific form of resolution, other than requiring the four choices referenced above. It is expected that the board of directors will include a recommendation as to how shareholders should vote. Companies may vote uninstructed proxy cards in accordance with the board's recommendation only if (1) a recommendation for the frequency vote is included in the proxy statement, (2) an abstention with respect to this vote is permitted on the card, and (3) language is included regarding how uninstructed shares will be voted in bold on the card.

What is the effect of the vote?

The advisory vote by shareholders on the frequency of the say-on-pay vote is not binding on the company or the board of directors of the company. The non-binding nature of this vote must be explained in the proxy statement.

What are other requirements?

The company must disclose on an amended Form 8-K the company's decision regarding how frequently it will conduct the shareholder advisory vote following each advisory vote on such frequency. The number of votes cast for each choice (i.e., 1, 2, 3, or abstention) must also be disclosed on Form 8-K.

What is the impact on TARP companies?

A separate shareholder advisory vote on the frequency of the say-on-pay vote is not required of companies with outstanding indebtedness under the TARP, until all outstanding debt is repaid. These companies are already required to include an annual say-on-pay vote under the Economic Stabilization Act.

Comment:
Available information at this point indicates that just over 50% of companies are recommending a triennial say-on-pay vote, followed by annual. Shareholder advisory firms on the other hand favor an annual vote, but would consider a company's rationale for a less frequent vote. Arguments for a triennial vote are best supported if the company has addressed any excessive or unreasonable pay practices, if they can demonstrate a history of strong alignment between pay and performance that serves the interests of shareholders, and if the level of compensation delivered relative to performance is not excessive or out of line with market practice, and if the structure of incentive compensation does not put the future of the company at risk.

Disclosure and Approval of Golden Parachute Arrangements

Disclosure requirements:

What disclosure is required?

Under the final rule, "golden parachute" compensation paid to or on behalf of a named executive officer based on or related to an acquisition, merger, consolidation, sale or other disposition of all or substantially all of the issuer's assets must be disclosed in both prescribed tabular and narrative formats. The target company seeking shareholder approval of such transactions must disclose any related written or unwritten compensation agreements or understandings it has with its named executive officers or the named executive officers of the acquiring company. Disclosure is limited to any named executive officer in the company's most recent filing requiring summary compensation table disclosure.

The elements of merger related compensation that must be separately disclosed in the prescribed tabular format include:

• Cash severance payments;

• Dollar value of accelerated stock awards, in-the-money option awards for which vesting is accelerated, and payments in cancellation of stock and option awards (i.e., dollar value reported will be based on the consideration per share, if such value is a fixed dollar amount, or otherwise based on the average closing price per share over the first five business days following the first public announcement of the transaction);

• Pension and nonqualified deferred compensation benefit enhancements;

• Perquisites, other personal benefits, and health and welfare benefits;

• Tax reimbursements; and

• Any other compensation not specifically referenced in the rules.

Payments amounts subject to single and double trigger arrangements may need to be disclose separately in the table to meet the "clear and simple" requirement and must be separately identified by footnote. There are no exclusions for deminimis perquisites or personal benefits, as would otherwise be the case for the 402(j) annual proxy statement disclosure of potential payments upon termination of change-in-control.

Any material conditions or obligations applicable to the receipt of payments such as non-compete, non-solicitation, non-disparagement or confidentiality agreements; and their duration, and provisions regarding waiver or breach must be disclosed. The soliciting company must also disclose specific circumstances that would trigger payments, and whether payments would or could be lump sum, annual; their duration; and any material factors regarding each agreement.

Smaller reporting companies as defined above are not exempt from this disclosure requirement.

When is the disclosure required?

The compensation agreements and arrangements that directly relate to a particular merger transaction must be disclosed in the proxy statement that is seeking shareholder approval of this transaction. Although not required, if a company chooses to include the tabular and narrative disclosure as described above in their annual proxy statement, such disclosure would satisfy the 402(j) annual disclosure requirements with respect to potential payments upon a change-in-control.

Shareholder advisory vote on "golden parachute" compensation

What is required?

A separate nonbinding shareholder vote is required with respect to "golden parachute" compensation arrangements that are subject to the disclosure requirements outlined above (i.e., agreements or understandings between the soliciting/target company and the named executive officers of either the
soliciting/target company or the named executive officers of the acquiring company in connection with a transaction). Smaller reporting companies as defined above are not exempt from this shareholder advisory vote on "golden parachute" compensation in connection with mergers or other covered transactions.

When is the vote required?

This advisory vote is required in the proxy statement that is soliciting the approval of the merger or related transaction, and only with respect to compensation agreements or understandings that directly relate to such transaction. A separate advisory vote on "golden parachute" compensation disclosed in the merger proxy will not be required if such compensation arrangements were included in the executive compensation disclosure that was subject to a prior say-on-pay vote. This exemption from the separate advisory vote requirement in the merger proxy is valid only if:

• The disclosure of such compensation agreements or understandings in a prior proxy statement met the tabular and narrative disclosure requirements outlined above; and

• The same compensation agreements or understandings subject to the prior vote remain in effect without change with respect to the related transaction.

Any new "golden parachute" agreements or revisions to such agreements not previously subject to a say-on-pay vote will be subject to a separate merger proxy shareholder advisory vote. In the merger proxy, one table will be required to disclose all golden parachute compensation, including provisions subject to a prior vote and new arrangements. A second table in the merger proxy will be required to disclose only compensation relating to new or modified provisions.

Comment:

Companies will be faced with a decision to either include the required tabular and narrative disclosure of "golden parachute" compensation as part of a current annual meeting executive compensation disclosure subject to a say-on-pay approval vote, or in the event of a later transaction, subject the compensation arrangements to a separate approval vote in the merger proxy. An exemption from a separate approval vote in the merger proxy is gained by including such agreements as part of a current annul meeting say-on-pay vote; however, the merger proxy vote on such compensation becomes more complicated if there are any changes to these agreements that at the time of the transaction have not been incorporated in an earlier say-on-pay vote. Individual company facts and circumstances will influence this decision.