SEC Adopts Final Rules on Shareholder Advisory Votes; Thoughts On the First Reported Frequency Votes

As widely reported, on Tuesday the SEC in a 3-2 vote (again) adopted its final rules to implement the shareholder advisory vote requirements under Section 951 of the Dodd-Frank Act, including Say-on-Pay, the frequency vote, and Say-on-Parachutes. The final rules are similar to the proposed rules issued in October 2010. There are a few notable changes:

• The final rules defer the advisory requirements for smaller reporting companies until shareholders meetings on or after January 21, 2013.
• As in the proposed rules, public companies will need to disclose, in light of the shareholders’ frequency vote, how frequently they will conduct Say-on-Pay votes until the next frequency vote. Under the proposed rules, the disclosure generally would have been in the Form 10-Q for the quarter in which the vote was conducted. Under the final rules, the disclosure is required 150 calendar days after the annual meeting date (but not less than 60 days before the deadline for shareholder proposals for the following year). This gives the company around five months after the annual meeting to make the disclosure, compared to around three months under the proposed rules.
• As proposed, Rule 14a-8 has been amended so that the company can exclude future shareholder proposals on the frequency of Say-on-Pay, but only if the board follows the wishes of the shareholders expressed in the frequency vote. Under the proposed rules, the company could exclude the shareholder proposal if it followed the alternative (annual, biennial or triennial) that received the most votes on a plurality basis. Under the final rule, the company can only exclude the proposal if one of the alternatives gets a majority vote and the company follows this alternative.
• Consistent with the proposed rule, the final rule does not mandate specific language for the Say-on-Pay resolution, but Rule 14a-21(a) now includes an example that provides some guidance. On the language of the frequency vote resolution, the final rule doesn’t provide an example or much detail on the required language. No significant change here.
• There are no major changes from the proposed rules on the say-on-parachutes vote and the new Item 402(t) disclosures of change in control payment arrangements. The final rule on these matters is effective for merger proxies filed on or after April 25, 2011. I will discuss the say-on-parachutes rules in more detail in a future post.

Of course, the ON Securities Cheat Sheet has been updated to summarize the final rules, as well as some recent changes to the SEC’s published timetable in adopting rules under the Dodd-Frank Act. Better yet, it still prints out on two normal pages, and I haven’t had to resort to a microscopic font size! Check it out.

The First Frequency Votes Are In; What Do They Mean?

The other major development regarding the frequency vote is that, this week, the first shareholder votes under Dodd-Frank are occurring, and the results will be reported by next week. A majority of companies so far have recommended triennial votes, and we will soon get an idea of the power of ISS’ “one-size-fits-all” policy to always recommend an annual vote. Yesterday, Monsanto held its annual meeting, and it reported a 63% vote for an annual frequency, even though management had recommended the triennial alternative. Results of other meetings should be reported on Form 8-K filings by next week.

Ted Allen of ISS, writing in RiskMetrics Group’s Risk & Governance Blog, speculated that, if the first several companies have similar results, this will cause many calendar year companies to consider recommending an annual vote in the first place: “If investors at other large-cap firms follow suit in the next few weeks, it appears likely that these results may sway boards at companies with late spring meetings to recommend annual votes. More results like today's vote at Monsanto may prompt undecided institutions to back annual votes as well.”

However, I think it’s important not to over-emphasize the importance of the first few votes. Monsanto had around 33% voting “no” on Say-on-Pay, and their financial results in 2010 did not appear to be very good. I would guess that the shareholders’ demand for an annual vote has something to do with the fact that shareholders don't fully trust the compensation committee’s judgment on compensation matters and want a forum every year. I'm still guessing that, if a company has built trust with shareholders, the shareholders will be more likely to support a triennial request, and that not all the shareholders will buy in to ISS's blanket recommendation for an annual vote. Also, I would predict that a small or mid-cap company is more likely to be able to get a triennial vote, because they are more likely to be able to “fly under the radar.”

I asked Francis Byrd, an officer of Laurel Hill Advisory Group and the author of the Byrd Watch Corporate Governance & Proxy Review, for his opinion on the above matters, and his response was interesting:

Voting results on frequency and the SOP vote will reflect, to a greater or lesser extent, the performance of the company, the quality of pay and how it is derived, and the ISS vote recommendation (which accounts for as much as 20-25% at some larger issuers). While I can’t comment directly on Monsanto, I would posit that those companies with greater trust and more open relationships with their shareholders will fare better with their frequency and SOP vote request.

If a company has had a history of poor pay practices (as defined by ISS), battles with large shareholders over compensation and poor financial returns, those headwinds may likely to be too much for the board’s frequency vote recommendation to overcome. A shareholder vote of 65% or more against a board recommendation cannot be entirely laid at the feet of ISS – the amount and quality of engagement (on both frequency and the advisory vote itself) with shareholders prior to the annual meeting and the stock’s total return may well have played a larger role in the defeat.

I believe it is still much to early in the season to determine how later filers will behave. Not all the filers seeking triennial votes may be routed. Irrespective of the Monsanto outcome, companies need not be victims. Positive SOP votes are about doing the homework and building in the time to conduct an investor outreach program that properly identifies shareholders and addresses their pay concerns.

On your last point about smaller filers and those with large retail share ownership it may be easier for some to “fly under the radar” but only if their top holders are supportive of the pay and frequency and if they can capture the retail holder votes they need. Remember, SOP will not be as familiar to retail shareholders voting this item – who likely to have not heard of it – and they may require some education efforts to bring them up to speed on an issue where they are likely to be supportive of management. For some small and mid-size companies this will necessitate calling campaigns to reach and educate their investors.

Regardless of the prospects, this is all uncharted territory. Companies that recommend a triennial vote do need to be prepared for the possibility that the shareholders will disagree. If that happens and a company goes with the wishes of its shareholders, there should be no negative consequences of an initial recommendation for a triennial vote. Further, if this happens, the company can always try again in a year or two, to see if they can persuade shareholders to support a triennial vote going forward.