Financial Reform Watch : Financial Services News & Information : Blank Rome Government Relations Lobbying Firm : Government Relations, Corporate Governance : Financial Reform Watch Law Blog

Prior to the passage of Dodd-Frank, the SEC was empowered to reward whistleblowers that helped the government prosecute successful enforcement actions. However, the SEC was not legally obligated to do so. With little incentive to bypass corporate compliance programs, whistleblowers availed themselves of such programs in hopes of motivating the company to address possible wrongdoing. But now, prospective whistleblowers are motivated to do just the opposite, to take advantage of the potential payday that lies ahead.

Those who fear that whistleblowers will now proliferate believe that the SEC should require whistleblowers, in order to be eligible for an award, to use available internal reporting procedures before going to the government. The SEC is not likely to warm to this position, because of the concern that such a requirement will have a chilling effect on the number of legitimate tips. Possible retaliation by employers is very much at the heart of the SEC’s concerns about such an approach.

In response to corporate concerns about Dodd-Frank rendering compliance programs ineffective, the SEC has proposed two rules:

First, the SEC has proposed a 90-day reporting window, which allows an employee to report complaints to internal compliance personnel and still be eligible for the reward if the company, in the whistleblower’s estimation, fails to properly address the complaint. This 90-day grace period also may serve to limit the number of allegations ultimately brought to the SEC, by allowing a company’s internal compliance program time to investigate and possibly ferret out meritless claims.

The challenge, however, is that this grace period may not be enough to temper those who aspire to a big payday and, thus, are less motivated by a desire to see wrongdoing addressed internally. Moreover, 90 days may not be enough time for a company to conduct a thorough investigation, particularly in instances where the allegations implicate a statute such as the Foreign Corrupt Practices Act. Thus, the grace-period proposal ultimately may do little to stem the undermining of corporate compliance programs.

Second, the SEC proposes to take into account, when determining the award amount, whether a whistleblower reported the violation through internal compliance mechanisms before approaching the government. The SEC will consider higher percentage awards for whistleblowers who first report violations through these programs. In effect, then, the SEC seeks to counter any disincentive to internal reporting arising from the prospect of a significant award. (Under this proposed rule, however, whistleblowers who fail to avail themselves of these programs before going to the government will not be penalized, provided that they have a “fear of retaliation or other legitimate reasons.”)

Here, too, skeptics abound. Some commentators on the proposed rules take the position that whistleblowers may opt to “leave money on the table” by bypassing their internal compliance program rather than use those procedures, for fear that the employer might otherwise address the problem altogether or in a manner that minimizes the whistleblower’s potential award. This view hews closely to the position that the SEC mandate use of internal compliance programs in order for whistleblowers to be eligible for an award. Because that position might discourage potential whistleblowers, however, a middle road may be necessary.

One possible solution that has been put forth by some commenting on the proposed rules is to require whistleblowers to report allegations of wrongdoing simultaneously to the government and to the company, assuming the company has implemented and advertised an internal compliance program. Simultaneous reporting would allow the company to investigate the matter, while the SEC defers action until it hears back from the company. A whistleblower would be permitted to bypass reporting to the employer in instances where a legitimate reason, as determined by the SEC, exists.

This middle-of-the-road deferral approach acknowledges the government’s interest in encouraging valid tips and the interests of well-intended companies in being afforded an opportunity to conduct internal investigations that might, where appropriate, stave off unnecessary expenditure of corporate and public resources. Furthermore, because of the simultaneous-reporting requirement, whistleblowers can take comfort in knowing that the government, and not just the company, is aware of their allegations of wrongdoing. Presumably, an employer will think twice about retaliating against a whistleblower, whose identity—or, at a minimum, their legal counsel’s identity—is known to the government. This might very well prove to be a workable, win-win approach.

Absent such an approach, companies can best protect themselves by identifying any potential issues as early as possible through internal audits. Once identified, companies must then respond quickly and definitively to address the problem. Anything short of early and prompt response places the company at risk of government action initiated by a heavily-incentivized whistleblower.

In most instances, the foregoing regulatory requirements, which are discussed in greater detail below, require additional rule making by the SEC or the national securities exchanges to fully implement these changes.

The Act imposes enhanced regulation on the derivatives market, and the participants in this market, including public companies and requires approval of the appropriate committee for derivative activities will be required. The Act also provides for additional changes impacting public companies, including new benefits for whistleblowers, expanded liability for securities violations, increased restrictions on short sales, relief for non-accelerated filers and smaller reporting companies from obtaining auditor attestation of internal controls, disclosure of votes by institutional managers, requirements related to credit rating agencies and committee approval for derivative activities.

This post highlights certain of the more significant changes resulting from the new legislation generally applicable to public companies. These changes will impact disclosure and other requirements, many of which will be applicable for the 2011 proxy season. This post does not cover changes in banking law, hedge fund requirements and requirements applicable to derivatives and credit unions affected by the Act that may indirectly impact public companies. Changes to SEC Regulation D which impact private offerings of securities by public companies are discussed in more detail in our previous post on July 26.

Regulatory Changes Impacting Proxy Statement Disclosures and the Annual Meeting Process

Say-on-Pay and Golden Parachute Proposals. Beginning six months after the enactment of the Act, public companies will be required to provide in their annual proxy statement, at least once every three years, a non-binding shareholder vote approving executive compensation. The non-binding shareholder vote on this proposal, which has been called a “say-on-pay” proposal, does not override board decisions in this regard, does not create or imply any change to fiduciary duties of the board of directors, and will not preclude shareholder compensation proposals1. In addition, at the first shareholders’ meeting to which this requirement will apply, each public company must include another shareholder proposal in its proxy materials which permits shareholders to determine the frequency of the inclusion of a “say-on-pay” proposal, in its proxy materials (i.e., every year, every two years, or every three years). Companies must also provide a vote, at least every six years, on whether the “say-on-pay” vote will occur every one, two or three years.

In addition to the say-on-pay proposal, whenever shareholders are asked to approve an acquisition, merger, consolidation or sale or other disposition of all or substantially all of a company’s assets at a meeting occurring six months after the enactment of the Act, the company or the person soliciting proxies must disclose in the related proxy statement or information statement any agreements or understandings concerning compensation payable to named executive officers as a result of such transaction, referred to as a “golden parachute payment,” and shareholders will have a separate non-binding vote to approve such payments2. The disclosure must include the aggregate total of all such compensation and the conditions upon which it may be paid to, or on behalf of, an executive officer of the public company. Similar to the “say-on-pay” proposal previously described, the results of this vote do not override board action or affect the board’s fiduciary duties under state law.

New Compensation Committee Requirements. Within 360 days of enactment of the Act, the SEC is required to instruct the exchanges to adopt rules that, in effect, mandate that compensation committees consist only of independent directors3. “Independence” is to be defined, but such definition must take into consideration any consulting or other fees paid by the issuer to a committee member and whether the committee member is an affiliate of the issuer. Compensation committees will also have the authority to engage independent consultants and counsel at the issuer’s expense, but must first consider factors to be identified by the SEC affecting independence4. These factors must include the following:

• the provision of other services to the public company by the person that employs the advisor;
• the amount of fees received from the public company by the person that employs the advisor and the percentage such fees represent of the person’s net total revenue;
• the policies and procedures of the person that employs the advisor, which are designed to prevent conflicts of interest;
• any business or personal relationships between the advisor and any member of the compensation committee; and
• any stock of the public company owned by the advisor.

Proxy statements for meetings occurring one year after enactment of the Act will have to disclose whether a compensation consultant was engaged, whether there were any conflicts of interest and how they were addressed. These new requirements will place more emphasis on director independence and highlight conflicts of interests occurring with compensation consultants.

Additional Executive Compensation Disclosures. Public companies will be required to disclose in annual proxy statements the relationship between executive compensation and financial performance, taking into account any change in stock value and dividends paid (which may be done in a graph), and also must disclose (i) median compensation of all employees (excluding the CEO); (ii) CEO compensation; and (iii) the ratio of median employee compensation to CEO compensation. This provision will be implemented by amendment to the SEC’s rules but the Act does not specify any timeframe required for the SEC’s adoption of such amendments.

Disclosure Related to the CEO/Chairman Structure. The SEC must issue rules that require public companies to disclose in annual proxy materials sent to shareholders the reasons why the company chose:

• to have the same person serve as Chairman of the Board of Directors and CEO; or
• different individuals to serve as Chairman of the Board of Directors and CEO5.

The SEC previously promulgated similar disclosure requirements related to this issue and many companies have already addressed this disclosure. Other companies separated these two positions or have elected a lead director as this has long been considered a best practice in corporate governance.

Limits on Discretionary Voting by Brokers. The Act requires that the national securities exchanges adopt rules prohibiting brokers from voting shares held in “street name” on the election of directors, executive compensation or any other “significant matter” as determined by the SEC by rule unless the brokers have received voting instructions from the beneficial owner of the securities. The Act does not specify a timeframe for the adoption of rules related to this requirement, however, it is anticipated that these rules will be adopted and effective for the 2011 proxy season.

Proxy Access. The Act provided the SEC with the authority to adopt rules permitting shareholders of a public company, under specified circumstances, to utilize the company’s proxy solicitation materials to nominate directors submitted by the shareholders.6 The SEC has the discretion to determine the eligibility requirements shareholders must meet to utilize the company’s proxy statement to nominate directors. Given that the shareholder proxy access debate has raged for years, this requirement of the new law should come as no surprise as the SEC, on several occasions, has previously proposed rules addressing this issue, including proxy access rules proposed as recently as June 2009. Accordingly, SEC Chairman Mary Schapiro has indicated in a recent speech that the SEC intends to adopt rules related to proxy access that will be in effect for the 2011 proxy season.

New Hedging Disclosure. Public companies will be required to disclose in their annual proxy statements whether any employee or director is permitted to purchase financial instruments that are designed to hedge or offset any decrease in the market value of the company’s securities (i) granted to the employee or director by the company as compensation or (ii) otherwise held directly or indirectly by the employee or director. Although the Act requires the SEC to adopt rules on hedging disclosures, no timeframe for the adoption of such rules was specified in the Act.

Additional Changes Impacting Public Companies

Amendments to Regulation D Governing Private Offerings. Rules under the Securities Act of 1933, as amended (the “Securities Act”), provide for a series of tests to determine whether an investor is an “accredited investor.” The legislation requires the SEC to amend any of the net worth standards to exclude the value of the investor’s primary residence from the calculation of net worth7 and to provide for a periodic adjustment of the $1 million threshold beginning four years after the date of the legislation’s enactment. These changes which are effective immediately are discussed in detail in Blank Rome Corporate and Securities Alert No. 4.

The law also authorizes the SEC to undertake a review of the accredited investor tests that apply to natural persons, other than the net worth standard, to determine whether the requirements of the definition should be adjusted in light of the public interest, the protection of investors and the economy. The SEC may make changes to the rule, other than the net worth standard, as it deems appropriate, taking these considerations into account.

Beginning four years after the date of the Act’s enactment, and at least every four years thereafter, the SEC must review the definition of “accredited investor” set forth in Rule 215 under the Securities Act (or any successor rule) to determine whether the definition in its entirety should be amended for the protection of investors, in the public interest or in light of the economy. While the accredited investor test set forth in Rule 215 is identical in all material respects to the definition applicable to Rule 506 offerings, it is unclear whether the amendment of Rule 215 pursuant to the Act will affect the definition of accredited investor that is applicable to Rule 506 offerings.

Within one year after the law is enacted, the SEC must amend Rule 506 to include specified “bad boy” disqualifications for offerings exempt under that rule. First, the SEC must enact rules that provide for disqualifications under Rule 506 that are “substantially similar to” the provisions under Rule 262 of the Securities Act. Under Rule 262, an issuer is disqualified from relying upon that exemption if the issuer (or its predecessors or affiliated issuers), or its officers, directors, promoters, 10% or greater stockholders, or underwriters (and their affiliates) meet any one of several “bad boy” disqualifications.

In addition to these disqualifications, the legislation will require the SEC to adopt rules disqualifying an offering or sale of securities under Rule 506 if a person is subject to a final order of a state securities commission; a state insurance commission; or a state or federal authority supervising banks, savings associations or credit unions, including the National Credit Union Administration, that is issued within 10 years of the filing of the offer or sale and is based upon a violation of any law or regulation prohibiting fraudulent, manipulative or deceptive conduct, or that bars the person from:

• associating with any regulated entity;
• engaging in the business of securities, insurance or banking; or
• engaging in savings association or credit union activities.

Reliance on Rule 506 would be prohibited for any person that has been convicted of any felony or misdemeanor in connection with the purchase or sale of any security or involving the making of a false filing with the SEC, no matter when the conduct occurred.

While Rule 262’s “bad boy” provisions had been currently applicable to offerings of securities under rarely-used Rule 505, the imposition of these requirements to Rule 506 offerings will serve to lessen the ability of some issuers to rely upon this widely-used exemption to raise capital. This amendment will also require an additional layer of due diligence for issuers relying upon Rule 506 in these transactions, especially necessitating deeper scrutiny into the background of the issuer’s controlling persons, 10% or greater beneficial owners, promoters, underwriters and related persons.

Enhanced Clawback Requirements for Executives. Public companies will be required to adopt and disclose clawback policies requiring current and former executive officers to repay any incentive compensation (including options) received during the three-year period prior to an accounting restatement, due to material non-compliance with financial reporting requirements, in excess of what they otherwise would have been paid. This provision significantly increases the clawback provisions currently contained in Section 304 of the Sarbanes-Oxley Act of 2002 which provide for a one-year clawback of compensation in the event of the restatement of financial statements due to material noncompliance with the financial reporting requirements under the securities laws where the executive was engaged in misconduct which resulted in the erroneous financial statements. These requirements will be implemented through the adoption of rules by the national securities exchanges which will prohibit the listing of the securities of any company which does not adopt such clawback policies.

Benefit for Whistleblowers. The Act adds a new benefit for whistleblowers8. Under this new provision, subject to certain exceptions, the SEC will have the authority to pay to a whistleblower who provides “original” information leading to an enforcement of a judicial or administrative action where the monetary sanctions recovered exceed $1.0 million, 10–30% of any monetary sanctions the SEC or other agency collects. Such payments will be in the SEC’s sole discretion. This provision does not apply to whistleblowers that are members or employees of a self-regulatory organization (for example, a securities exchange), the Department of Justice, the Public Company Accounting Oversight Board or a regulatory or law enforcement agency. Additionally, a whistleblower will be denied an award if such whistleblower is convicted of a criminal violation related to the judicial or administrative action for which the whistleblower provided original information, or if the whistleblower gained the original information through the performance of the audit of the company’s financial statements. Whistleblowers will also receive payments if their information leads to a successful related action by another governmental agency. Additionally, the federal whistleblower protection provided by the Sarbanes-Oxley Act was extended to prohibit retaliation or discrimination by subsidiaries or affiliates of a public company. Under the Act, public companies, including their consolidated subsidiaries or affiliates, may not discharge, demote, suspend, threaten or otherwise discriminate against a whistleblower.

Expanded Liability for Securities Violations. The legislation also expanded the Securities Act which governs securities offerings to add “aiding and abetting liability” for any person that “knowingly or recklessly” provides substantial assistance to another person in violation of the Securities Act. Section 20(e) of the Securities Exchange Act of 1934 was amended to enhance the current “aiding and abetting” liability to include “reckless” acts.

Increased Restrictions on Short Sales. The Act also requires the SEC to adopt rules requiring financial institutions to disclose information regarding short sales. Brokers will also be required to notify customers that such customers may elect not to allow their shares to be lent to third parties by the broker. Brokers are also required to notify their customers if the customers’ securities are used in short sales and indicate that the broker may receive a fee in connection with lending the customers’ shares. These are helpful provisions in that they enable retail brokerage customers to be put on notice of their rights with respect to the short sale of their securities held in brokerage accounts. Given the excessive and prolonged short sales have the effect of decreasing the market value of the affected publicly traded securities, investors in the affected securities, have an interest in limiting these activities as opposed to facilitating these short sales. The new SEC rules will likely reduce short selling problems plaguing certain public companies.

Enhanced Regulation of Swap Transactions and Committee Approval for Swap Transactions. The Act imposes enhanced regulatory requirements on the derivative market and its participants as well as public companies. Such enhancements include a broader definition of regulated financial instruments included as derivative instruments, and new requirements applicable to exchange trading and central clearing of derivative instruments. In addition, more stringent margin and capital requirements will be required for derivative market participants The Act also requires that the appropriate committee of any public company that engages in derivative activities approve the decision to enter into covered “Swap transactions” that rely upon commercial “end-user” exemptions from the new clearing requirements in the Securities Exchange Act of 1934 and the Commodity Exchange Act. The approval provision was effective upon enactment of the Act.

Relief from Section 404’s Requirement for Independent Auditor Attestation of Internal Controls for Small Public Companies. One of the positive elements of the Act for public companies was the relief provided for non-accelerated filers9 from Section 404(b)10 of the Sarbanes-Oxley Act which requires the company’s independent public accountants to attest to management’s assessment of the effectiveness of the company’s internal controls. Under the Act, companies that are not large accelerated filers or accelerated filers will be exempt from the requirement to provide such auditor attestation report. The SEC is also required to conduct a study on reducing the burden on companies with market capitalization between $75 million and $250 million of complying with Section 404(b) of the Sarbanes-Oxley Act.

Disclosure of Votes by Institutional Managers. The Act requires institutional investment managers to disclose at least annually how they voted on say-on-pay proposals and golden parachute proposals. It is anticipated that the SEC will issue rules related to the location and timing of this disclosure.

Credit Rating Agencies’ Consent and Disclosures. Many issuers refer to the ratings of their debt and preferred securities in their registration statements and in other SEC filings which are incorporated by reference into their registration statements. Rule 436(g) of the Securities Act historically allowed issuers to include or incorporate such credit ratings into their registration statements without obtaining the rating agencies’ consent. The Act repeals Rule 436(g). As a result of the provisions of the Act, certain rating agencies have said that they will not furnish consents for the time being. The SEC has set forth the following guidelines with respect to the disclosure of ratings information for non-asset backed securities offerings:

• no consent is required where an issuer includes disclosure about its credit ratings in a filing with the SEC in the context of a discussion of changes to a credit rating, the liquidity of the registrant, the cost of funds for a registrant or the terms of agreements that refer to credit ratings (collectively, “disclosure-related ratings information”);
• no consent is required where an issuer includes disclosure about its credit ratings in a free writing prospectus that complies with Rule 433 or in term sheets or press releases that comply with Rule 134;
• except as provided below, issuers may continue to use currently effective registration statements without the credit agency’s consent to any information regarding ratings included or incorporated by reference therein until the next post-effective amendment to such registration statement;
• a consent must be filed in connection with a prospectus or prospectus supplement that is first filed on or after July 22, 2010 that includes ratings information (other than disclosure-related ratings information as noted in the first bullet above);
• a consent must be filed if a subsequently incorporated periodic or current report contains ratings information (other than disclosure-related ratings information as noted in the first bullet above); and
• registration statements and post-effective amendments to registration statements (note that the filing of the issuer’s next annual report is deemed to be the post-effective amendment of a registration statement) that become effective on or after July 22, 2010 must include an appropriate consent if the registration statement includes or incorporates by reference any ratings information (other than disclosure-related ratings information as noted in the first bullet above).

Amendments to Regulation FD regarding Disclosure to Credit Rating Agencies. The Act requires the SEC to amend Regulation FD within 90 days of enactment of the Act to remove the exemption for communications with entities whose primary business is the issuance of credit ratings. Therefore, unless another exemption applies, public companies will not be able to provide material non-public information to credit rating agencies.

Establishment of a Risk Committee by Certain Publicly-Traded Bank Holding Companies. The FRB must require publicly traded nonbank financial companies that it regulates and publicly-traded bank holding companies with assets in excess of $10 billion, and may require smaller bank holding companies, to establish a risk committee responsible for the oversight of enterprise-wide risk. The committee must include such number of independent directors as the FRB determines appropriate (based on the nature of operations, size of assets, etc.) and at least one risk management expert. The FRB is required to issue final rules regarding this requirement not later than two years after the enactment of the Act, to take effect not later than 15 months after the one year anniversary of the enactment of the Act.

Application of the Act to Foreign Private Issuers. Although a majority of the provisions of the Act do not apply to foreign private issuers11, there are a couple of provisions that will impact foreign private issuers. For instance, a foreign private issuer with a security listed on an exchange will be required to adhere to the new compensation committee requirements unless the foreign private issuer provides in its annual report on Form 20-F the reasons why the foreign private issuer is not in compliance. In addition, as the enhanced clawback provisions for executives applies to all public companies with a security listed on an exchange, the clawback provisions for executives will apply to foreign private issuers unless the SEC in implementing regulations regarding the clawback provisions provides for a foreign private issuer exemption. The Act itself provides for no such exemption. As is the case with U.S. public companies, foreign private issuers that are non-accelerated filers will not be required to have the company’s independent public accountants attest to management’s assessment of the effectiveness of the company’s internal controls. Finally, the added whistleblower benefits and expanded liability for securities violations have the potential to impact foreign private issuers.

Action Items for Public Companies—Preparing for the 2011 Proxy Season and Beyond

In light of the Act’s new disclosure and corporate governance requirements, many of which take effect six months after enactment of the Act, public companies should consider taking the following actions prior to the 2011 proxy season:

1.  Plan Ahead for the 2011 Annual Meeting. The elimination of discretionary voting by brokers will undoubtedly create issues for companies with obtaining a quorum for the annual shareholders meeting or the vote for specific proposals requiring majority or super-majority votes. As a result, it will be important to review the company’s charter document or bylaws well in advance of the meeting to determine what the quorum requirements are for annual meetings and consult with counsel regarding whether amendments to modify these requirements are recommended. In addition, companies should plan on allowing extra time between the meeting and mail dates for the 2011 annual meeting or consider the retention of a proxy solicitor. These solicitation services will likely be in high demand in 2011 as a result of the elimination of broker voting and the other shareholder proposals required by the Act. Subject to the provisions of the final rules, if a company is only electing directors by a plurality vote, the company should also consider adding a proposal where directors have discretionary authority, such as the ratification of auditors. Thus, the addition of a proposal where discretionary voting is permitted will ensure the company meets its quorum requirements for the annual meeting.

2.  Anticipate Mandatory “Say-on-Pay” Proposal and Other New Compensation Disclosures. Given the mandatory “say-on-pay” proposal which will be effective for the first meeting of shareholders occurring six months after the enactment of the Act and other new disclosures related to compensation, the compensation committees will want to carefully consider how to address executive compensation disclosures in the company’s compensation discussion and analysis (“CD&A”) or elsewhere in the proxy statement. This will likely require a careful review and a potential rewrite of last year’s CD&A. It is suggested that companies attempt to streamline and clarify compensation policies for the benefit of shareholders reviewing this information. Since the vote on this proposal will likely set the stage for what will happen in future years, the presentation and content will be of critical importance this year.

Given the Act also requires disclosure of the relationship between compensation of executives and enhancing shareholder value (i.e., appreciation in the value of the company’s publicly traded equity), shareholders will continue to pay particular attention to how successfully the company aligned executive compensation with increasing value for shareholders as well as the combination of stock-based compensation and cash. It is anticipated that this disclosure will have to be more transparent with respect to executive compensation decision-making and the financial and other measures utilized to determine performance-based compensation. The financial crisis also focused attention on the compensation mix as contributing to the overall level of risk undertaken by executives. This Act provides incentive for compensation committees to review the interplay between risk and executive compensation and address any compensation policies or practices that encourage excessive risk-taking.

3. Evaluate Independence of Compensation Committee Members Under New Criteria. Given the new requirements applicable to compensation committees under the Act, as well as the new considerations applicable to the independence determination, the board should consider whether the composition of the compensation committee will meet the more stringent requirements of the Act and it should be noted that other requirements could be added by the SEC in the final rule when adopted. This review process should include the board’s evaluation of the relationships that exist with compensation committee members based upon these new requirements articulated in the Act. If the board determines that there are not an adequate number of compensation committee members that will meet the new requirements, it will be necessary to add new board members to this critical committee. Although it may be premature to embark on the process of adding new directors prior to the review of the SEC proposal, the company should have as a top priority the evaluation of the existing composition of this committee.

4. Reevaluate Clawback Provisions in Existing Compensation Arrangements. The expanded clawback provisions of the Act will likely require the amendment of existing company policies, as well as changes to compensation arrangements as well as plan documents and model agreements related to equity and other awards. This exercise will undoubtedly take some time to effect and may prove difficult with respect to implementation related to former officers. Prior to the adoption of SEC rules in this area, companies should include language compliant with the Act in new arrangements.

5. Analyze the Use of Compensation Committee Consultants. The changes in the Act with respect to compensation committee consultants will require a thorough evaluation of the selection process as well as a review of existing relationships and policies related to the solicitation of compensation consultants. It may be necessary to utilize a questionnaire for existing or new consultants for gathering the information necessary for the compensation committee to evaluate the consultants under the requirements of the Act. These requirements may also necessitate the implementation of policies similar to those used with the retention of a company’s independent auditors, including pre-approval policies. Companies should also consider adopting policy regarding the retention of consultants, counsel and advisors and the related procedures applicable to the retention of such advisors.

6. Determine How to Disclose and Calculate the Median Compensation Numbers. One of the most troubling aspects of the Act is clearly the disclosure of the ratio of the median of total annual compensation of all employees to the total annual compensation of the CEO. This requirement will be difficult (if not impossible) to calculate for many companies. Since the parameters are set forth in the law and the SEC rule cannot deviate from these parameters, companies will need an early start to gather the necessary data and draft disclosure to quantify and explain these numbers.

7. Amend Insider Trading Policy to Address Hedging. Hedging activities can often result in adverse effects and require specific policies to address these activities. Many public companies have policies addressing hedging, which are typically reflected in companies’ insider trading policies12. For companies that do not have such policies, consideration should be given to the adoption of such policies in anticipation of the issuance of disclosure rules on this topic by the SEC. In this regard, the board should consider whether these restrictions should apply only to directors and executive officers or to a broader group of employees. Additionally, consideration should be given to whether hedging activities should be prohibited or subject to an established pre-approval policy.

8. Rationalize Board Management Structure. The Act’s requirements regarding disclosure of the rationale for the company’s board management structure, as well as existing SEC disclosure requirements on this topic, will necessitate a review of the structure currently utilized. Companies with a combined chairman and CEO position will undoubtedly have to rethink this combination or provide additional support for continuing the combination of these two critical roles.

9. Review and Revise Key Corporate Governance Documents. Changes to the whistleblower provisions of the Sarbanes-Oxley Act as well as other corporate governance requirements of the Act necessitate the review and revision of the company’s whistleblower policies and procedures as well as other key corporate governance documents such as the code of conduct and committee charters. At a minimum, the whistleblower policy must be revised to include employees of the public company’s subsidiaries and affiliates whose financial information is included in the company’s consolidated financial statements. Further, this presents a good opportunity to review other documents as part of the company’s compliance review and assess the effectiveness of these documents.

10. Take Action with Respect to New Swap Approval Requirements. The Act’s new Swap approval requirements will require the Board to designate a committee to review and approve Swap transactions. An appropriate amendment to the selected committee’s charter will also be necessary. Finally, consideration needs to be given to what procedures need to be put in place to insure compliance with the new requirements applicable to Swap transactions.

11. Consider Establishing a Risk Committee. The requirement of the Act related to risk committees for non-bank financial companies and certain bank holding companies will undoubtedly affect best practices in this area for all public companies. Given the recent focus on risk-related issues particularly in light of the financial crisis, boards of public companies may consider establishing a risk committee to be responsible for the oversight of company-wide risk management practices. Whether this committee has a “risk management expert” as required for nonbank financial companies and certain bank holding companies will depend upon the complexity of organization, as well as other factors.

12. Educate the Board and Committees on the Act’s New Requirements. Given the myriad of changes required by the Act, it will be necessary to educate the board and affected committees regarding the Act’s requirements as well as the changes impacting the board and specific committees. For example, the Swap transaction approval requirements of the Act will also require the implementation of a new approval process as well as the education of the Board and the appropriate committees regarding the new approval requirements applicable to Swap transactions.

13. Develop and Implement Internal Controls to Ensure Compliance with the Act. In light of the numerous changes required by the Act, many of which will be implemented over a several year period, it will be necessary for public companies to develop and implement the appropriate internal controls and procedures to ensure compliance with the Act’s requirements on a timely basis. These controls will require a certain degree of flexibility given the manner in which the Act’s requirements will be implemented
 

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1. See generally section 951 of the Act
2. This separate approval of the golden parachute payment is not applicable if the golden parachute payment was previously the subject of a prior “say-on-pay” vote.
3. Generally does not apply to controlled companies.
4. Generally does not apply to controlled companies.
5. See generally, Section 972 of the Act.
6. See generally, Section 971 of the Act.
7. The SEC has indicated in a recent Compliance & Disclosure Interpretation that the amount of any indebtedness secured by the primary residence may be excluded from the value of the residence (where the amount of the debt exceeds the fair market value of the residence and the lender has recourse to the investor personally for such excess, such excess liability should be deducted from net worth calculation).
8. See generally, Section 922 of the Act.
9. A non-accelerated filer is a company with less than $75.0 million of public float held by non-affiliates on the last business day of the second fiscal quarter of the company’s fiscal year.
10. See generally, Section 989G of the Act.
11. Since the SEC’s proxy rules do not apply to foreign private issuers, provisions of the Act requiring additional proxy statement disclosure are not applicable.
12. Certain hedging transactions are prohibited by Section 16(c) of the Securities Exchange Act.