Dodd Frank Act- Corporate Governance Provisions 2011 Conference
Selected Talking Points for Panel Discussion re “DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT:Understanding the Regulatory Roadmap and the New Realities of Corporate Governance” A Panel Discussion atthe Summit 2011 Directors and Officers Training Conference Breakout Session I at 3:00-4:15 PM on Thursday, December 1, 2011 At the St. Regis Deer Valley Resort in Deer Valley, UtahModerator: Ronald S. Poelman, Senior Partner at Jones Waldo, Member of Board of Directorsof USANA Health Sciences, Inc. (Compensation Committee Chair and member of Audit Committee and Governance Committee), and President of the Utah Chapter of the National Association of Corporate Directors (“NACD”) 801-534-7311 firstname.lastname@example.orgPanel Members: Joshua Foukas, Assistant General Counsel and Vice President of Finance at USANA Health Sciences, Inc. 801-954-7823 Joshua.email@example.com Carol Beaumier, ExecutiveVice President and Global Financial Services Leader at Protiviti 212-603-8337 Carol.firstname.lastname@example.org Steven R. Walker, General Counsel, Secretary & Director of the Board Advisory Services at the National Association of Corporate Directors (“NACD”) 202-572-2101 email@example.com Richard Blake, Partner at Wilson, Sonsini, Goodrich & Rosati firstname.lastname@example.org 1Error! Unknown document property name.
Purpose The purpose of this panel discussion is to educate and inform the audience regardingthegeneral corporate governance issuesof the Dodd-Frank Wall Street Reform and ConsumerProtection Act (the “Dodd-Frank Act”), with a focus on not only the status and requirements ofthe rules, but also on what companies should be doing to respond to them. Also, as time allowsat the end, we will discuss the advisability of the “federalization” of corporate law, includingwhether the various requirements of the Sarbanes-Oxley Act and the Dodd-Frank Act haveachieved their intended objectives.Overview We will address the following provisions of the Dodd-Frank Act: Section Title Section 922 Whistleblower Protection (or better said, “Bounties”) Section 951 Shareholder Vote on Executive Compensation Disclosures (“Say- on-Pay”) Section 952 Compensation Committee Independence (including independence of advisors to the Committee) Section 953 Executive Compensation Disclosures (including pay v. performance, median salary of employee v. salary of CEO) Section 954 Recovery of Erroneously Awarded Compensation (“Clawbacks”) Section 955 Disclosure Regarding Employee and Director Hedging Section 957 Voting by Brokers (cannot vote discretionarily on executive compensation and “other significant matters” in addition to votes for board members) Section 971 Proxy Access (by shareholders to the Company’s proxy statement for the nomination of directors)Section 922—Whistleblower Protection (or better said, “Bounties”)Final Rule issued May 25, 2011(SEC Release No. 34-64545)Effective Date: August 12, 2011 2Error! Unknown document property name.
Summary of Whistleblower Rules Bounty:If a whistleblower (any person or group)voluntarily provides the SEC with“original information” (including information that “materially adds” to the SEC’s information)based on the whistleblower’s independent knowledge or analysis, that leads to or significantlycontributes to a successful enforcement action by the SEC (or Dept. of Justice, US bankregulators, US self-regulatory organizations, and US state attorneys general in criminal cases)that results in the collection of monetary sanctions (including disgorgements, etc.) of at least$1M, then the whistleblower is entitled to receive between 10-30% of the collected monetarysanctions.(Note—the Sarbanes-Oxley Act only covered “financial fraud.”) Protection from Retaliation: Additionally, if a whistleblower is discharged, demoted,harassed, etc. in his or her job due to the whistle-blowing, then the whistleblower can sue forreinstatement or 2X back pay and all litigation costs, including attorneys’ fees.(Note—thissignificantly expands the protections for whistleblowers under the Sarbanes-Oxley Act.) Selected Questions re Whistleblower Rules1. The SEC estimates that it will receive 30,000 tips annually, with the number of personsreceiving a bounty each year to be approximately 130. Is it advisable for the government to paysuch potentially huge bounties to whistleblowers? Do such bounties turn every citizen into a“witch hunter?”2. Is it fair that whistleblowers can remain anonymous (until called to testify, etc.)?3. The SEC included in the rule incentives to encourage a whistleblower to report the matter tothe Company internally first before reporting it to the SEC. These incentives are as follows. Indetermining the amount of the award, the SEC may consider whether the whistleblower firstreported the matter to the Company internally. Also, the whistleblower can receive a bounty ifthe whistleblower reports first to the Company internally, and then the Company reports thematter to the SEC. And, the date that the whistleblower reports to the Company internally willbe deemed to be the date of the whistleblower’s report to the SEC. Are these incentivessufficient to encourage whistleblowers to report to the Company first?4. Whistleblowers are only eligible to receive a bounty if they report the information to the SECfirst, before the SEC gets it from someone else. Will this encourage whistleblowers to rush intothe SEC with any information they can find, however plausible?5. Attorney whistleblowers can circumvent the attorney/client privilege by claiming that theyreasonably believed that their whistle-blowing was necessary “to avoid a substantial financialinjury to a third party” (an exception to the attorney/client privilege in many states). Is itappropriate for attorneys to become whistleblowers in this manner? 3Error! Unknown document property name.
6. Violations of the Foreign Corrupt Practices Act (“FCPA”) are a recent focus of the SEC’senforcement actions. Will employees in foreign countries be motivated by this newwhistleblower bounty to report every payment to a foreign official as a violation of the FCPA?6. Companies will be significantly disadvantaged if they learn of the alleged violation from theSEC instead of from the employee directly. What can companies do to encouragewhistleblowers to report a matter internally first before going to the SEC?7. Companies have 120 days from the date that an employee reports an alleged violation untilthey must report the matter to the SEC. Is this 120-day time period sufficient to allow acompany to conduct an investigation?8. The anti-retaliation protections apply to a whistleblower even if the whistleblower ultimatelydoes not qualify for a bounty and whether or not the information turns out to relate to an actualviolation of the law. Does this mean that a Company must retain the services of perpetual “witchhunters?”Section 951-- Shareholder Vote on Executive Compensation Disclosures (“Say-on-Pay”)Final Rule issued on January 25, 2011(SEC Release No. 33-9178)Effective Date: April 4, 2011 Summary of “Say-on-Pay” RulesAdvisory Vote on Compensation. Companies must submit a resolution at least once every threeyears to provide shareholders with an “advisory” (non-binding) vote on the compensation oftheir named executive officers (the “say-on-pay vote”). Additionally, at least every six years,companies must allow shareholders to vote whether want to have their say-on-pay vote annually,bi-annually, or tri-annually.Advisory Vote on “Golden Parachutes.” Companies must disclose all “golden parachute”compensation arrangements in all change-of-control proxy statements and must allow theshareholders to have an “advisory” (non-binding) vote on such arrangements. Selected Questions re “Say-on-Pay” Rules1. Are shareholders qualified to make compensation decisions for the company’s executives?2. The “say-on-pay” vote by shareholders is non-binding, so what significance does it have to acompany’s board of directors? Should we give shareholders an “advisory” vote on othersignificant decisions of the board of directors?3. After all the “hubbub” over “say-on-pay,” only a few companies had their shareholdersdisapprove of their compensation plans (less than 45 companies and only 2% of the S&P 500). 4Error! Unknown document property name.
Also, this advisory vote is “yes-or-no.” So, what is a board of directors or a compensationcommittee to do with a “no” vote by its shareholders? What is a board of directors or acompensation committee to do with a “no” vote on “golden parachute payments?”4. If a company receives a “no” vote from its shareholders regarding executive compensation,will this act as a deterrent to qualified executives to either join or stay with the company?5. How can a company best comply with this “say-on-pay” requirement? A vote every year? Avote every three years?Section 952—Compensation Committee IndependenceProposed Rule issued on March 30,, 2011 (SEC Release No. 33-9199)SEC plans to adopt final rule in Nov-Dec 2011 (and the exchanges must adopt final rules nolater than one year thereafter, so the 2012 proxy season is the earliest that these rules would bein force) Summary of Provisions re: (i) Independence of Members of the CompensationCommittee and (ii) Disclosures re Conflicts of Interest for Compensation Advisors Independence of Members of the Compensation Committee. National stock exchangesmust adopt rules requiring that members of the compensation committee of listed companies be“independent,” with reference to such factors as the member’s source of compensation andwhether the member is otherwise affiliated with the company. Compensation Advisors. The compensation committee must consider variousindependence factors before engaging a compensation advisor, consultant, or legal counsel (an“advisor”). This factors must include: (i) what other services are provided to the company by theemployer of the advisor; (ii) what percentage the fees of the advisor’s employer are representedby the fees paid to that firm by the company; (iii) the policies re conflicts of interest by theadvisor’s employer; (iv) any business or personal relationship between the advisor and themembers of the compensation committee; and (v) whether the advisor owns stock of thecompany. Disclosure re Compensation Advisors. Companies must disclose in their proxystatements whether the Compensation Committee retained a compensation advisor and if anyconflict of interest occurred in connection with such engagement. If there is a conflict, then thecompany must disclose what it is and how it is being handled by the company.(Note—theserequirements expand those imposed by the SOX Act.) 5Error! Unknown document property name.
Selected Questions re: (i) Independence of Members of the Compensation Committeeand (ii) Disclosures re Conflicts of Interest for Compensation Advisors1. What will the “independence” standards for the members of the Compensation Committeelook like? Will they be as stringent as those for the members of the Audit Committee (a SOXAct requirement)?2. Many public companies already have “non-employee,” “outside,” or “independent” membersof the Compensation Committee in order to comply with certain requirements of the federalsecurities law, federal tax law, and exchange listing requirements. These include: (i) the “non-employee director” requirement in order to take advantage of an exemption from the short-swingprofit provisions under Section 16(b) and Rule 16b-3 of the Exchange Act; (ii) the “outsidedirector” requirement in order to take advantage of the deductibility of certain compensation paidto top executives under Section 162(m) of the Internal Revenue Code; and (iii) the current NYSEand NASDAQ listing standards require that a company’s compensation committee be composedof “independent” directors. Will the “independence” standards for members of the compensationcommittee be even stricter than these existing requirements? Will this mean that some existingmembers of the compensation committee will be required to resign from such committee? Ifthese “independence” requirements are not stricter than the existing ones, then why was this“independence” mandate necessary in the Dodd-Frank Act?3. The proposed rules make it clear that it is not necessary that a compensation advisor beindependent—only that any conflicts of interest be disclosed. But, by such disclosure, it ispresumed that a conflict of interests by a compensation advisor is inherently bad? Is such aconflict inherently bad?4. The enhanced disclosure requirements for compensation advisors applies regardless ofwhether the compensation advisor provides advice with respect to only broad-based plans andnon-customized benchmark data (which are both currently exempt). Why is this disclosurenecessary to shareholders?5. What should companies be doing now to anticipate these new rules re compensation advisors?Section 953—Executive Compensation DisclosuresNo Proposed Rule Yet. The SEC plans to propose this rule in Nov-Dec 2011.The SEC plans to adopt the final rule in Jan-June 2012. Summary of Executive Compensation Disclosure Requirements Compensation v. Performance. Companies must provide in their proxy statements adescription of the relationship between the compensation paid to executives and the financialperformance of the company, including any change in the value of the company’s stock,dividends, or other distributions. 6Error! Unknown document property name.
Ratio of CEO Compensation to Median Compensation of Employees. Companies mustdisclose: (i) the median annual compensation of all employees (excluding the CEO); (ii) the totalannual compensation of the CEO; and (iii) the ratio of (i) to (ii).(Note—these requirements will be in addition to the existing requirement of a CD&A and theexpanded executive compensation tables that arose in 2006 and to the “pay risk” and otherenhanced disclosures of 2009.) Selected Questions re Executive Compensation Disclosure Requirements1. Will this information alter whether a shareholder buys, sells, or holds the stock?2. What will the SEC choose as its measurements of a company’s “performance?”3. Many times, a company establishes a compensation plan that attracts, retains, and motivates itsexecutives, but then the performance of the company falters for reasons unrelated to thecreativity, initiative, and effort of its executive team. So, will a comparison of the company’sperformance to the compensation of the executive team be instructive or relevant toshareholders?4. Companies will be required to calculate the median compensation of all its employees—ahuge administrative burden. Is this burden worth the resulting comparison to the CEO’scompensation?5. Is the ratio of the CEO’s compensation to the median compensation of an employee evenmeaningful to a shareholder? Should these ratios always be in the same range for similarlyperforming companies?6. Three senators recently wrote to the Center for Executive Compensation, arguing that thedisclosure of CEO v. employee pay could improve the chances that worker’s wages will rise,thereby strengthening the economy. Is this plausible?7. What should companies be doing now, if anything, to anticipate compliance with these newrules re disclosure of executives compensation?Section 954—Recovery of Erroneously Awarded Compensation (“Clawback”)No Proposed Rule Yet. The SEC plans to propose this rule in Nov-Dec 2011.The SEC plans to adopt the final rule in Jan-June 2012. 7Error! Unknown document property name.
Summary of “Clawback” Rules The SEC must adopt a rule requiring the national exchanges to adopt rules requiring theirlisted companies to adopt and implement and disclose its policy under which the company willclawback from its current and former executives “incentive-based compensation (including stockoptions)” if the company is later required to restate its financial statements due to “material non-compliance of the issuer with any financial reporting requirement under the securities laws.”The clawback applies to “excess” of what the executive was paid according to the erroneousfinancial statements, when compared to what the executive should have been paid under thecorrected financial statements. The clawback extends for three years. No misconduct is requiredby the executive. The companies—not the SEC—are charged with enforcing these clawbacks.(Note—the clawback provision under the SOX Act applies only to the CEO and CFO, looks backonly 12 months, and applies only in the case of misconduct.) Selected Questions re “Clawback” Rules1. How will the SEC likely define “material non-compliance with any financial reportingrequirement under the securities laws?2. If an executive exercises and sells “stock options” during this three-year period, how will theSEC calculate the amount of the “excess” compensation to the executive?3. The statute does not require a “material” restatement. So, will a board of director be requiredto enforce this clawback even in the event of a non-material restatement?4. Because the company itself must adopt and enforce its own policy re clawbacks, will the boardof directors be sued by shareholders over its non-enforcement or less-than-strict enforcement ofits policy?5. What should companies be doing now to anticipate these new rules re clawbacks?Section 955—Disclosure Regarding Employee and Director HedgingNo Proposed Rule Yet. The SEC plans to propose this rule in Nov-Dec 2011.The SEC plans to adopt the final rule in Jan-June 2012. Summary of Rules re Adoption and Disclosure of Policy re Hedging The SEC must adopt rules requiring companies to disclose whether employees anddirectors are permitted by the company to hedge or offset any decrease in the market value of thecompany’s stock that either: (i) is granted to the employee or director as part of such person’scompensation; or (ii) is “held, directly or indirectly” by such person. 8Error! Unknown document property name.
Selected Questions re Adoption and Disclosure of Policy re Hedging1. Should companies adopt anti-hedging policies now in anticipation of these new rules?2. Should a company prohibit hedging on any stock held by an employee or director, whethercompensatory or not? How is this decision affected by a requirement that an executive ordirector hold a certain number of shares?3. If, for example, an executive exercises a stock option, then the compensatory nature of thatstock has ceased. Should an executive be prohibited from hedging such shares?4. What should companies be doing now to anticipate these new rules regarding hedging?Section 957—Voting by BrokersFinal Rule (partial) issued on September 9, 2010 on an “accelerated basis” (SEC Release No. 34-62874)(Note—NSYE Rule 452 was amended to prohibit brokers from voting discretionarily on any“compensation matter,” but the SEC postponed any determination of “other significant matters”on which brokers might be prohibited from voting in the future.) Summary of Restrictions on Discretionary Voting by Brokers National securities exchanges (not just the NYSE) must adopt rules that prohibitdiscretionary voting by brokers on: (i) matters regarding “executive compensation;” and (ii) “anyother significant matter.” These prohibitions are in addition to the existing prohibition ofdiscretionary voting by brokers for the election of a member of the board of directors. As notedabove, the SEC postponed any determination of “other significant matters” and only approvedthe addition to NYSE Rule 452 of the prohibition regarding “executive compensation.” Thisnew prohibition applies to all votes regarding “executive compensation, including all “say-on-pay” votes and votes on any equity incentive plan. Selected Questions re Restrictions on Discretionary Voting by Brokers1. NYSE Rule 452 and similar rules already prohibits brokers from voting on any equityincentive plan. Do shareholders really care to vote on all votes regarding executivecompensation?2. Companies have already found it difficult to obtain majority votes on the election of directors.Will this new prohibition similarly make it difficult for companies to obtain majority votes reexecutive compensation? What should companies do to ensure that the required vote isobtained? 9Error! Unknown document property name.
3. This new rule regarding votes on executive compensation will concentrate power in the handsof shareholder activists and proxy advisors. Is this a good thing?4. What can companies do to reduce the impact of these new broker voting restrictions?Section 971—Proxy AccessFinal Rule issued August 25, 2010(SEC Release No. 33-9259) (vacated as to Rule 14a-1—butnot as to the companion amendment to Rule 14a-8—as described below)Original Effective Date: November 15, 2010Vacated on July 22, 2011 by the US Court of Appeals for the District of Columbia (“DCCircuit”) Summary of Proxy Access Rules, Subsequent Ruling by the DC Circuit, andSubsequent Action by the SEC, including the Effectiveness of Rule 14a-8 SEC’s New Rule 14a-11 and the Amendments to its Companion Rule 14a-8. In August2010, the SEC issued its final rules for proxy access, meaning allowing certain shareholders toadd their nominees to the company’s proxy statement. Specifically, the SEC adopted new Rule14a-11, pursuant to which shareholder(s) who had held at least 3% of a company’s stock for atleast three years would have been able to nominate a limited number of directors to thecompany’s board of directors and have those nominees included in the company’s proxystatement. When the SEC adopted new Rule 14a-11, it also amended Rule 14a-8(i)(8) under theExchange Act to eliminate a company’s ability to exclude from its proxy statement a proposalthat relates to the right of shareholders to nominate directors or to have such nominees includedin the company’s proxy statement. The Business Roundtable and the US Chamber of Commerce’s Challenge to this NewRule. As anticipated, on September 29, 2010, the Business Roundtable and the US Chamber ofCommerce sought a stay of effectiveness of Rule 14a-11, alleging that the Rule was “arbitraryand capricious” in violation of the Administrative Procedures Act (the “APA”) and that, in thisregard, the SEC had failed to adequately access the Rule’s effect on “efficiency, competition,and capital formation,” as required by Section 3(f) of the Exchange Act (adopted in 1996). It isinteresting to note that the US Chamber of Commerce had won two other earlier victories in theDC Circuit against the SEC with respect to certain banking laws, making this proxy accessvictory the third such victory in that court in the last six years (Eugene Scalia, the son ofSupreme Court Justice Antonin Scalia, was the winning attorney on each such case). Shortlythereafter, the SEC issued a stay on the effectiveness of both Rule 14a-11 and its companionRule 14a-8 (which stay has now expired, as described below). The DC Circuit Vacates Rule 14a-11 and Sets a Higher Standard for Future SECRulemaking. The DC Circuit vacated Rule 14a-11 on July 22, 2011, finding that the SEC hadacted “arbitrarily and capriciously” in failing to adequately assess the economic effects of the 10Error! Unknown document property name.
Rule. The court stated that the SEC had “inconsistently and opportunistically framed the costsand benefits of the rule; failed adequately to quantify the certain costs or to explain why thosecosts could not be quantified; neglected to support its predictive judgments; contradicted itself;and failed to respond to substantial problems raised by the commentators.” Additionally, thecourt extensively discussed what the SEC must do in the future to satisfy the APA and Section3(f) of the Exchange Act. This decision has prompted the SEC to hire more economists and hasprompted various trade groups to consider other challenges to the SEC’s rulemaking under theDodd-Frank Act or otherwise (the whistleblower rules, for example). But, the Amendments to Rule 14a-8 are Now in Effect. Despite the fact that the DCCircuit vacated Rule 14a-11, as described above, that decision had no effect on the SEC’scompanion amendments to Rule 14a-8, which, again, eliminated a company’s right to excludedirector nomination and proxy access proposals from its proxy statement when such proposalsare submitted by its shareholders. Although, as described above, after the US Chamber ofCommerce originally filed its lawsuit, the SEC stayed the effectiveness of both Rule 14a-11 andRule 14a-8, this stay has now expired. The result of this is that Rule 14a-11 has now beenvacated by the DC Circuit and Rule 14a-8 is now in effect. The effectiveness of Rule 14a-8likely will lead to a “private ordering process,” whereby companies will adopt or not varioussuch proxy access rules in their bylaws. Some companies may decide to pre-empt any suchshareholder proposal by proposing their own. Most companies, however, will likely wait and seeif any shareholder makes such a proposal, whereupon they will either allow such proposal to besubmitted to the shareholders for a vote, or they will immediately propose their own such rules(and exclude the shareholder proposal, claiming “substantial implementation” under Rule 14a-8). Selected Questions re Proxy Access Rules, Subsequent Ruling by the DC Circuit, andSubsequent Action by the SEC, including the Effectiveness of Rule 14a-81. Why should a shareholder have access to a company’s proxy statement in order to nominate adirector? Why shouldn’t shareholders be required, as they have in the past, to mount their ownproxy fight?2. Is the 3%/3-year threshold too low? Too high?3. The SEC claims to have spent 21,000 staff hours over two years drafting the proxy accessrules, with the cost-benefit analysis being 60-pages long. Was the DC Circuit correct in findingthat that SEC acted “arbitrarily and capriciously” and failed to adequately assess the effects ofthe Rule on “efficiency, competition, and capital formation?”4. Based on this decision by the DC Circuit, will there likely be other challenges to other rulesunder the Dodd-Frank Act (the whistleblower rules, for example)?5. Now that Rule 14a-8 is in effect, so that companies must allow shareholder proposals redirector nominations and proxy access, what should companies do? Should they pre-empt suchproposals with their own? Should they wait and see if shareholders submit such proposals andthen respond (note—at least two such proposals have already been submitted)? Should theyrespond by allowing the shareholder proposal to be submitted to the shareholders for a vote, or 11Error! Unknown document property name.
should they then submit their own proposal (and exclude the one from the shareholder based on“substantial implementation”)? Should companies stay with the 3%/3-year standard?Open Question re the “Federalization” of Corporate Law for Public CompaniesBoth the Sarbanes-Oxley Act and the Dodd-Frank Act have—in an unprecedented fashion—plunged the federal government into mandating the governance of public companies. Is this agood trend? Have all the changes made public companies better? Are shareholder betterprotected? Has future fraud and abuse now been eliminated so that a crisis such as the Dot.comBust and the Sub-Prime Mortgage Collapse will never happen again? 12Error! Unknown document property name.