Speech by SEC Staff:
Remarks at the ABA Business Law Section, Delaware Business Law Forum
Meredith B. Cross
Director, Division of Corporation Finance
U.S. Securities and Exchange Commission
October 22, 2010
Thank you so much Larry, it is great to be here this evening. When I saw the attendance list I felt a bit star-struck. This is quite a group, and I’m honored that you asked me to come talk with you tonight.
Before I get started, I need to give the standard SEC staff disclaimer. My remarks tonight are my own personal views, and do not represent the views of the Commission or other members of the staff.
This evening I’ll provide some insights into the Division’s current agenda, focusing in particular on projects that have governance implications. As you know, many priority items following the financial crisis, some of which are reflected in the Dodd-Frank legislation, relate to corporate governance, and our proxy plumbing project has many governance implications as well.
Corporate Governance Regulation and State Law
I think it’s critical that we have an open and constructive dialogue about how we can all best address investor concerns about corporate governance in a timely and workable manner. This Delaware Law Forum is a great place to encourage that dialogue since Delaware occupies such a critical place in our corporate governance landscape.
Investors look to the SEC to get them the information they need to assess corporate governance practices at public companies, which informs their voting and investment decisions. We’ve enhanced these disclosures over the last few years, and, in light of Dodd-Frank, will be doing more of that soon, as I’ll discuss shortly.
We also administer the proxy rules, which bring life to corporate governance matters through shareholder votes. In this role, we also administer the shareholder proposal process, through which many investors raise governance concerns for their fellow shareholders to consider at particular companies.
And on occasion, as a result of Congressionally-mandated minimum listing standards — including those in Sarbanes-Oxley and Dodd-Frank — we require the stock exchanges to set particular governance standards for listed companies. Or, as is now set out in Dodd-Frank with the requirement for “say-on-pay” votes, Congress may mandate a particular governance practice for public companies directly.
But in the vast majority of cases, when questions or concerns come up about particular corporate governance practices and why the SEC isn’t doing something about them, as we all understand, the answer is that corporate governance is largely a state law matter. And over half of public companies are incorporated in Delaware, so Delaware corporate law holds the key to most of these questions and concerns.
Understanding and making our rules work well with state corporate law was one of my highest priorities when I re-joined the staff. I learned in private practice that retaining special Delaware counsel was often the best course, because it’s better not to try to “hum a few bars” when it comes to complex state law matters. Indeed, when I was being considered for my job, I said that I thought one of my first hires should be a “Delaware Attorney Fellow” who could help us in this area.
Thank goodness I got permission to hire such a person, and then got lucky enough to find the perfect person — Larry Hamermesh. Larry is an incredible resource for us. I could go on and on, but I won’t, since I’ll embarrass him. And he’s not only smart, but he’s nice and humble too. The only thing I will say that isn’t the most flattering about his legal skills is that I don’t think he read the fine print when he signed up to come work at the SEC. He thinks he has a time-limited fellowship that lasts through next spring or summer. But, actually, he can’t leave to return to Widener until he provides an equally good replacement, and since that’s impossible, he’s with the SEC to stay!
So, with that background, I’ll jump into our agenda, some tough issues we face, and how we are going about getting from here to there.
It’s no secret that we have a lot of rules to write to implement the Dodd-Frank Act. One of my friends recently remarked that lately my Division has been running at about one release a week — I’m not sure about that, but there are lots of them for sure. I always have a draft release, or at least a term sheet for one, in my briefcase.
I’ve added staff from Disclosure Operations to our rulemaking office temporarily to deal with the increased workload, and I have my senior special counsels each running rulemaking projects. I’m committed to producing high-quality, timely work. I’m very proud of the work we are producing, and grateful to the staff for knocking themselves out to do a great job. We keep saying that it is a marathon, not a sprint. But right now we feel like it is a sprinting marathon.
Of course, the burden shifts to you after we get our proposals out, since we need your comments, and we know we are giving you an awful lot to do. The comment periods are in many cases short, and I am really sorry about that, but that’s necessary in order to make our statutory deadlines. The input that we’ve been getting in our pre-rulemaking e-mail boxes has really been helpful as we develop our proposals, and we hope you will keep providing input to us.
As you know, there are many provisions in Dodd-Frank that address corporate governance matters, particularly with regard to compensation. I testified in Congress a few weeks ago about our efforts to implement these provisions, and we regularly get asked for status updates on our progress in getting these rules in place. I’ll briefly describe where we are and what we have left to do.
First up is our “say-on-pay” rulemaking under Section 951 of Dodd Frank. As you know, Congress adopted requirements for three new votes at public companies. First, a “traditional” say-on-pay vote at least once every three years; second, a “say-on-frequency” vote at least once every six years, through which investors will advise whether they would like say-on-pay votes every year, every other year, or every third year; and, third, a “say-on-parachutes” vote, where investors will cast advisory votes in mergers on the golden parachutes for specified executives. The say-on-pay and say-on-frequency votes are required starting at meetings on or after January 21, 2011, whether or not we adopt rules by then. The say-on-parachutes votes will be required after we adopt the new disclosure rules about golden parachutes for merger proxy statements, as required by Section 951.
The Commission approved rule proposals to implement these provisions this week, and they were posted on our website Monday afternoon. The comment period ends November 18. When you have a chance to review them, I think you will see that we stuck very close to the statutory mandate, and took an approach similar to how the Commission approached implementation of say-on-pay for TARP companies. The Commission didn’t tell companies how they needed to word their say-on-pay resolution, or dictate substantial new disclosures for the say-on-pay vote. I think that companies will want to think hard about how they describe their pay decisions, since shareholders presumably will be focused on that disclosure when they decide how to vote. But, again, the Commission did not propose to change those disclosures. The Commission did include a proposal to require disclosure in the CD&A of how consideration of previous say-on-pay votes affected pay decisions, since we thought that would be of interest to shareholders.
The release clarifies the Commission’s view that the say-on-frequency vote has to give shareholders the choice of one, two or three years, or to abstain. I understand that some thought a different approach — such as a management proposal for a particular number of years — should be proposed, but, the Commission’s proposal would not implement the provision that way. Of course, management is free to make a recommendation about how frequently they believe the vote should be held.
On golden parachutes, Section 951 requires the Commission to adopt new disclosure rules for disclosure of these arrangements, and the proposal includes detailed new rules for that. The release does not include a proposed requirement to add that disclosure to the annual meeting proxy, in order to avoid increasing burdens. But companies would be allowed to include it in the annual meeting proxy if they would like to take advantage of the provision in Section 951 exempting them from the say-on-parachutes vote at the time of a merger if the disclosure about the parachutes has previously been voted on. We don’t know if companies will want to provide disclosure to take advantage of that possibility when they haven’t determined that they are going to be acquired in the future, so the Commission did not propose to make that disclosure mandatory for annual meeting proxies.
Like the rules for TARP say-on-pay, the release does not specify what shares vote in say-on-pay votes. We received a request to address that, but it was not clear how that should be addressed, or on what basis. The release includes requests for comment on that point, and I hope you will weigh in on that. We also received requests for the Commission to specify what vote would be sufficient to “approve” the frequency vote, since a plurality is not something normally addressed under state law for matters other than elections of directors. However, since the vote is only advisory, we did not see a need to resolve that question. The Commission did propose that if a company implements the choice of the plurality of holders, a shareholder proposal asking for a frequency vote would be excludable as substantially implemented under Rule 14a-8.
The last point I’ll mention on the say-on-pay release is that the Commission included a few transition matters, pending completion of the rulemaking, that are designed to help with this first proxy season. First, the Commission said it wouldn’t object if companies do not file proxies in preliminary form if the say-on-pay votes are the only matters presented that require such a filing. Second, the Commission said that it wouldn’t object if companies include one, two, three years or abstain on the proxy card (or one, two, or three years, without discretionary authority), notwithstanding Rule 14a-4’s requirements. And third, the Commission said it wouldn’t object if TARP companies, which are required to provide a say-on-pay vote every year, don’t include the frequency vote until they are no longer subject to the TARP voting requirement. While these positions might not solve for every question or concern pending completion of the rulemaking, I’m hopeful that, together with the proposing release, they give you enough guidance and relief (where needed) to comfortably get ready for the upcoming proxy season.
Uninstructed Broker Votes
Dodd-Frank also requires that the exchanges amend their rules governing uninstructed broker votes to prohibit voting on compensation matters, such as the say-on-pay votes. The New York Stock Exchange, NASDAQ, and ISE have already changed their rules, which will be effective for the first round of mandatory say-on-pay votes starting in January, and others are in the process of doing so.
Compensation Committee Listing Standards
I expect the Commission’s next governance-related Dodd-Frank rulemaking will be to implement Section 952, which requires the Commission to mandate new listing standards for compensation committees. This covers both compensation committee member independence, and retention of consultants and advisers to the compensation committee. Section 952 has many similarities to the Sarbanes-Oxley provisions for audit committees, so I expect our proposed rules will also bear some similarities as well. However, unlike auditors, companies are not required to have compensation consultants, much less independent ones, so there may be places where the rules diverge. One thing we are considering is how the Commission should sync-up the new disclosure requirements about compensation consultants and conflicts of interest that are required to be adopted under Section 952 with the disclosure requirements on the topic that were adopted last year, so as to reduce burdens and avoid confusion.
The Commission’s rules for the listing standards have to be effective by July 16, 2011, and the new disclosures need to be adopted for meetings on or after July 22, 2011, so we are aiming to get a proposal out soon.
Other Dodd-Frank Governance Rulemakings
One of the more widely-publicized provisions of Dodd-Frank, Section 953, will require companies to calculate and disclose the median total compensation of all employees, and the ratio of CEO compensation to that figure, in accordance with rules that govern disclosure of executive compensation. This provision is raising concerns for many about how difficult it may be to perform that calculation. The Commission plans to propose rules to implement this requirement next summer, so there is time for us to hear your views and consider them in our rulemaking.
Another new Dodd-Frank mandated disclosure requirement that the Commission plans to propose next summer is disclosure of the relationship between senior executives’ compensation actually paid and the company’s financial performance. I gather there are many questions raised by this provision, such as what pay is covered and whether to mandate a specific method of calculating performance, so those will be important issues as we prepare our proposal for the Commission’s consideration. Next summer the Commission also plans to issue a proposal to require disclosure of whether employees or directors are permitted to hedge against a decrease in value of company securities granted as part of their compensation.
Next summer the Commission also plans to propose new standards under which listed companies will be required to develop “clawback” policies for reclaiming incentive-based compensation from current and former executive officers after certain financial statement restatements. I have been hearing that this provision raises several complex concerns, including what to do about incentive compensation that has both formulaic and discretionary components, whether the board will retain any discretion, and what time period is covered, so I encourage you to provide input on it in advance of our rulemaking.
Finally, as you are probably aware, Section 956 requires the SEC to work with our fellow financial regulators to adopt regulations or guidelines for certain firms that we regulate that would prohibit incentive-based compensation arrangements that encourage inappropriate risks. For the SEC, this would include broker-dealers and investment advisers that fall within the scope of the section. This provision obviously goes beyond disclosure. The banking regulators have been engaged in reviews of this issue with respect to incentive compensation at the banks for some time, and, as I said at my Congressional hearing, the Commission staff is preparing for the process of reviewing compensation programs at firms we regulate and working with our fellow regulators to prepare to issue these regulations or guidelines.
So, that wraps up the compensation and governance aspects of our Dodd-Frank rulemaking. As you can see, there is a lot ahead of us. And this doesn’t include the many other Dodd-Frank projects, like asset-backed securities, Regulation D revisions, Section 13(d) revisions, and specialized disclosures, like Congo conflict minerals, extractive industries, and mine safety, as well as derivatives and credit rating agencies.
But, even if we are busy, we are committed to addressing other issues that need our attention. For example, and germane to this group, Chairman Schapiro has said, and I have repeated, that we can, and we will, make time to take the necessary steps to address the issues raised in our proxy plumbing release.
I’m sure that many of you have read the release and are familiar with it, so I’m not going to go through it point by point. Big picture, we are looking for input on whether the proxy voting system operates with the degree of accuracy, transparency, and efficiency that is needed; whether the proxy voting system appropriately promotes informed communication among investors and issuers; and whether there are issues that we should address concerning voting by persons without a true economic interest in the shares they are voting and, if so, how.
We ask a lot of hard questions in that release about hot button topics, such as the appropriate regulatory response to the significant role played by proxy advisory firms, the fees paid by companies to proxy service providers and the constraints under our current OBO/NOBO system on companies’ ability to communicate with their stockholders. And we look forward to your comments on these topics. I understand that we have received a large number of comment letters, and that they already demonstrate that there will be plenty of spirited debate on these topics, and I look forward to reviewing those letters.
We also address a panoply of other topics, including a couple that I believe may be particularly relevant for this group — dual record dates and empty voting. With regard to the first topic, we are looking at how best to make our rules line up with the changes to Delaware law, and whether this is something that issuers really want to, and will, use. The concept release asks for input on this, including whether the Commission should wait to see how popular the dual-record-date provision is before providing a regulatory response or, in the alternative, whether our rules are discouraging use of dual record dates and we won’t get a true picture until we revise our rules. My main concern is how we can coordinate our rules with the dual record date approach to make sure that we get the necessary disclosures in front of investors at the right time, and I look forward to your thoughts on that point.
With regard to the second topic, empty voting, the Commission is considering, and looking for input on, the extent to which shares are voted by persons without a commensurate economic interest in the shares, and what effects, if any, such voting may have on the proxy voting system overall. There are clearly important state law implications when you raise questions about voting, and we look forward to your views as to what, if anything, the Commission should be doing in this area
Though the comment period for the concept release just ended on Wednesday, if you have comments that you have not yet submitted, please do not hesitate to send them in. We make every effort to consider the comments we receive, even after the close of the comment period, and we would welcome your thoughts.
Thank you so much for inviting me to join you tonight, and for your attention. As you can see, we have a lot of work ahead of us, and I want to thank you in advance for your expert and thoughtful input. Larry tells me that you may have some questions for me, and I’d be happy to try to answer them to the extent time permits.