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.
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
“...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.
Differences in the Senate and House bills
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.
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.
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.
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