Markets Update: New SEC Rule Proposals

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On July 1, 2009, the Securities and Exchange Commission (the "SEC") unanimously voted in favor of two new rule proposals that will have broad implications for boards of directors of public companies and the deliberative process used to decide and disclose meaningful information to investors and shareholders.

The first rule proposal would require any public company receiving money under the Troubled Asset Relief Program ("TARP") to provide a shareholder vote on executive pay in its proxy solicitations. The SEC issued the "say on pay" proposing release on July 1, 2009.

The second proposal approved by the SEC proposes a set of rule revisions to improve the proxy disclosure provided to shareholders of public companies regarding executive compensation and corporate governance matters. The SEC has not yet issued the proposing release on the second proposal. Both the TARP "say on pay" proposal and the increased proxy disclosure proposal, if adopted, will require the management and directors of public companies to take additional steps in preparing for enhanced disclosure requirements.

"Say on Pay" for TARP Recipients

The American Recovery and Reinvestment Act of 2009, enacted on February 17, 2009, amended the executive compensation and corporate governance provisions of Section 111 of the Emergency Economic Stabilization Act of 2008 ("EESA"). As amended, Section 111(e) of EESA requires any company receiving financial assistance under TARP to allow a shareholder vote to approve the company's executive compensation. The SEC's proposed rule is intended to provide clarity for TARP recipients regarding how to comply with their EESA Section 111 obligation.

The SEC proposal to amend Rule 14a-20 under the Securities Exchange Act (the "Exchange Act") would require that TARP recipients provide a separate shareholder vote in proxies solicited during the period in which any obligation arising from financial assistance provided under TARP remains outstanding.

This "say on pay" vote would only be required for meetings of securities holders in which proxies will be solicited for the election of directors. New Rule 14a-20 would also clarify that smaller reporting companies are not required to provide a compensation discussion and analysis in their proxy statements.

Finally, the SEC proposes to amend Item 20 of Schedule 14A to require TARP recipients to disclose in their proxy statements that they are providing a separate shareholder vote on executive compensation pursuant to the requirements of EESA, and to briefly explain the general effect of the vote, such as whether the vote is non-binding.

Enhanced Proxy Disclosure Relating to Executive Compensation and Corporate Governance Matters

The SEC also proposed a set of rule revisions applicable to all public reporting companies, intended to improve the proxy and information statement disclosure provided to shareholders regarding compensation and corporate governance matters. The proposed amended rules would require:

• Enhanced disclosure relating to the experience, qualifications and skills of a company's directors, executive officers and nominees;
• Disclosures relating to why a company has chosen a particular leadership structure, including disclosures relating to whether the board of directors has an independent chairperson;
• Enhanced disclosures concerning potential conflicts of interest with a company's compensation consultants; and
• Disclosure relating to how a company's compensation structure drives executive risk-taking and how the company's compensation committee manages such risks.

Company Response to Proposals

The unanimous vote by which the SEC determined to propose both proposals indicates that these rules likely will be passed in final form this year and be applicable for the 2010 proxy season. As a result, boards of directors - and, more specifically, compensation committees - need to begin looking into issues raised by the proposals.

TARP Recipients

Any company that is a recipient of TARP funds or subject to any conditions tied to the acceptance of TARP funds when it issues its 2010 proxy statement will have to include a shareholder vote on executive compensation in its proxy statement if the SEC's proposed rule is adopted.

Companies that already include "say on pay" votes in their proxy statements must determine whether such proposals would meet the requirements of new Rule 14a-20 and the amendment to Item 20 of Schedule 14A. Companies that do not yet include such items in their proxy statements must determine the form the shareholder vote will take. For example, will the shareholder vote be binding or non-binding?

Additionally, a proxy statement that would include a vote on executive compensation subject to proposed Rule 14a-20 must be filed in preliminary form and will be subject to comment from the SEC. This requirement further emphasizes the need for TARP recipients to begin preparing their executive compensation disclosure as soon as possible.

All Reporting Companies

Boards of directors should review the company's leadership structure and discuss whether any changes in that structure should be considered. For example, companies that presently have a structure combining the role of Chairman and CEO may want to benchmark that structure against competitors, consider whether separating the roles would achieve any meaningful advances in company or board priorities and consider disclosing its deliberations whether or not it determined to change the structure.

Boards of directors may also consider appointing a lead independent director in its board structure if it has not yet done so. Based on the potential requirement of enhanced disclosure requirements for the qualifications of board members, boards may also want to evaluate the constitution and makeup of the directors' expertise to ensure a diverse balance exists that is suitable for the businesses and priorities of the company. Finally, boards should consider how many management directors are included on the board and whether the number is appropriate.

Compensation committees should begin to review companies' executive compensation structure and determine what effect the current compensation structure has on executive risk-taking. To the extent that the compensation structure encourages executives to take excessive risks, compensation committees should consider revising the executive compensation structure.

Compensation committees should further consider how they manage risks relating to executive compensation and may wish to develop written policies relating to such risk management. Particular care should be taken to ensure that there is at least coordination, if not consistency, regarding risk management as between the Compensation Committee and the Risk Committee, the Audit Committee or other appropriate committee.

About the authors: Christine Edwards is a corporate partner in the Chicago office of the international law firm Winston & Strawn LLP. Ms. Edwards focuses on the regulation of the financial services industry- particularly the securities and banking industries - as well as corporate governance and public and regulatory policy issues. Christina Trotta is a corporate associate in the Chicago office of the firm.