Senate’s Financial Reform Bill Impacts Executive Compensation Rules and Corporate Governance

June 01, 2010

On May 20, 2010, the Senate passed the sweeping 1,600-page Restoring American Financial Stability Act of 2010 (the “Act”) containing significant proposed reforms on a wide array of issues affecting the financial services industry and companies with publicly traded stock on U.S. exchanges. Other Bingham McCutchen LLP client alerts will address significant market regulatory issues arising from the legislation; here we focus on the Act’s potential implications for executive compensation and corporate governance, and in particular on the impending new standards for “say-on-pay,” proxy access, compensation committee independence, compensation clawbacks, and shareholder suits. Significantly, the Act’s corporate governance reforms (and insurance company reforms) represent a shift toward federalization of many issues previously regulated solely by the states.

The Senate bill must now be reconciled with financial reform legislation passed by the House in December 2009. Representative Barney Frank of Massachusetts, slated to lead the conference committee charged with reconciling the House and Senate bills, has announced his intention to present the final bill for President Obama’s signature by July 4th. Several key provisions appear in both bills; to the extent the two bills differ, legislative leaders indicate they expect swift resolution.

The Senate bill authorizes the SEC to prohibit listing on a U.S. exchange of any public companies failing to adopt the corporate governance standards set forth in the Act. The SEC would continue to have the authority to exempt companies from any of the requirements based on size, market capitalization, number of shareholders or other criteria that the SEC deems appropriate, along with the ability to provide for transition and cure periods.

Investment companies will be among those watching the reconciliation process closely, as Rule 20a-1 under the Investment Company Act of 1940 could operate to apply the SEC’s new proxy requirements to registered funds. Further, listed closed-end funds and exchange-traded funds (ETFs) could be affected by proposed corporate governance requirements for listing on an exchange.

Executive Compensation

In the wake of public outrage from the compensation packages paid by TARP participant companies, both the Senate and the House have focused much of their corporate governance efforts on executive compensation issues.

Provisions included in both the Senate and House bills

  • “Say-on-Pay.” Following the lead of companies listed on U.K. exchanges, where “say-on-pay” has been mandatory since 2002, both the Senate and House bills require annual proxies to include a non-binding “say-on-pay” resolution. The resolution would give shareholders, beginning six months after the legislation’s enactment, the opportunity to cast an advisory vote on executive compensation disclosed pursuant to Item 402 of Regulation S-K. As has been widely reported in the financial press, shareholder anger over executive compensation has led several large public companies voluntarily to initiate shareholder advisory votes on executive pay. Congress also required companies that received TARP funds to provide for “say-on-pay” resolutions. At least three companies to date have already seen shareholders reject executive pay packages in “say-on-pay” votes. The Senate bill would also prohibit brokers from voting on “say-on-pay” proposals without instructions from the beneficial owners of the shares being voted.

    Critics of “say-on-pay” have noted the amount of power the change would place in the hands of proxy advisory firms, which have developed extensive compensation guidelines in connection with their issuance of proxy advice. Some proxy advisory firms also maintain consulting arms advising the companies whose proposals they purport to assess when issuing their ratings and proxy vote recommendations. The concentration of power in such firms, along with potential conflicts raised by their consulting arms, has caused some to advocate for additional oversight of such organizations in order to prevent “gatekeeper creep,” similar to that now being alleged against financial credit rating agencies. As SEC Chair Mary Schapiro told the Practicing Law Institute last November:


    “...we’ll be asking about the role of proxy advisory firms in corporate voting. Given the influence that these firms’ recommendations have on corporate voting outcomes, we’ll probe the need for rules to ensure that advisory firms are basing their research and recommendations on accurate and reliable information. And, that they are providing adequate disclosure of any conflicts of interest they may have in providing voting recommendations.”

    Proxy advisory firms may thus face future regulation. Credit rating agencies appear to be facing such regulation now: an amendment introduced by Senator Al Franken would create a Credit Rating Agency Board imposing far greater oversight of credit rating agencies.
  • Compensation Committee Independence. Both the Senate and House bills require the SEC to direct the securities exchanges to include as a listing requirement that executive compensation be set by “independent” directors. In defining “independence,” the exchanges would be required to identify factors impacting independence which could result in definitions that exceed those currently required under NYSE and NASDAQ listing standards, such as whether the director derived any income from the issuer through consulting or advisory fees or otherwise, and whether the director is otherwise affiliated with the issuer or one of its subsidiaries or affiliates. Depending on how such standards are implemented, they may result in an “independent” director more closely resembling an “outside” director as defined under Section 162(m) of the federal income tax code. Compensation committee members would be responsible for considering the independence of compensation consultants, outside counsel and other advisors retained by the committee, including the provision of other services provided to the issuer, the advisor’s policies and procedures regarding conflicts of interest, business and personal relationships, and stock ownership of the issuer by the advisor. Finally, the retention of compensation consultants would need to be disclosed, as would any conflicts of interest raised by such inquiries and how they were addressed.

Differences in the Senate and House bills


  • Compensation Clawbacks. In further response to shareholder outcry over executive compensation, the Senate bill strengthens SOX Section 304 to require the “clawback” of incentive-based executive compensation, including stock options, in the event of an accounting restatement due to material noncompliance with financial reporting requirements even if no one, including the executive whose compensation is at issue, engaged in misconduct. The provision would require the clawback of amounts paid based on overstated results for the three years preceding the restatement date. Compensation would be recalculated according to the restated performance.  

  • Link Between Pay and Performance. The Senate bill requires the SEC to amend Item 402 of Regulation S-K to require disclosure of how executive compensation relates to financial performance, taking into account changes in the value of stock and dividends and any distributions. The SEC must also issue rules requiring disclosure of how median employee compensation compares to CEO compensation.


Proxy Access

Both bills amend Section 14(a) of the Securities Exchange Act of 1934 to provide for shareholder access to proxies to nominate directors. The House bill requires, and the Senate bill authorizes, the SEC to prescribe rules and regulations granting shareholders such access. Senate backers and shareholder activists have pushed for proxy access for years, arguing that it will help remedy a perceived lack of management accountability. Under either provision, the SEC is likely to enact rules for shareholder access. As has been widely reported, the SEC issued a proxy access rulemaking proposal in 2009. After undergoing extensive notice and comment, the proposal was held in abeyance pending Congressional action clarifying the agency’s authority in this area. 

Majority Voting

The Senate bill requires that uncontested director elections be determined by a majority vote. Incumbent directors receiving less than a majority vote would be required to offer their resignation, which the Board could accept or decline. The Board would be required to make its reasoning public within thirty days. This provision reflects concerns by activist shareholders that the plurality voting standard in place at many public companies allows for the election of uncontested candidates even if they receive only one “yes” vote. The Senate bill retains the plurality standard for contested elections. The House bill does not have a majority vote provision. 

Separation of CEO and Chair

Under the Senate bill, within 180 days of enactment the SEC must require companies to explain in proxy statements why the positions of chairman and CEO are separate or combined. This provision reflects a view among some shareholder advocates that “best practices” requires separation of the roles of CEO and chair. Currently, Regulation S-K requires companies to disclose their leadership structure and why they believe the structure to be appropriate.

Securities Litigation

The final version of the Senate bill did not include an amendment, introduced by Senator Arlen Specter and mirroring a provision included in the House bill, that would have overturned the United States Supreme Court’s decision in Stoneridge Investment v. Scientific-Atlanta (2008) and Central Bank N.A. v. First Interstate Bank N.A. (1994), rejecting aiding and abetting liability under the federal securities laws. Those decisions have shielded lawyers, accountants, and other corporate advisors from aiding and abetting claims in shareholder suits. Senator Specter’s May 18, 2010 defeat in the Pennsylvania Democratic Senate primary makes the amendment’s reemergence in conference negotiations less likely.

Foreign issuers will be watching the reconciliation process closely to see if a provision in the House version survives that would expand jurisdiction over “f-cubed” litigation. The House version provides federal courts with jurisdiction over securities fraud actions involving “conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or conduct occurring outside the United States that has a foreseeable substantial effect within the United States.” The bill, on its face, extends jurisdiction only to actions brought by the SEC or the United States, in contrast with the National Australia Bank decision pending before the Supreme Court which involves private “f-cubed” securities litigation brought by shareholder plaintiffs.  


Reconciliation efforts between the House and Senate versions of the Restoring American Financial Stability Act of 2010 will continue over the next few weeks, but do not appear likely to prevent finalization of the bill and its delivery to the President for signature. Importantly, the corporate governance provisions of the bill reflect a continuing trend toward federalization of state law governance issues, and increasing oversight of “gatekeeper” rating services.



For more information about the subject matter of this alert, please contact any of the lawyers listed below:

Dale E. Barnes, Co-chair, Securities Litigation, 415.393.2522

Michael D. Blanchard, Partner, Securities Litigation Group, 860.240.2945

Laurie A. Cerveny, Partner, Corporate, M&A and Securities, 617.951.8527

Michael P. O'Brien, Partner, Corporate, M&A and Securities, 617.951.8302

This article was originally published by Bingham McCutchen LLP.