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SEC Reporting Companies: How Dodd-Frank Wall Street Reform and Consumer Protection Act Affects You

September 28, 2010

This summer, a new federal law called the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) was signed into law by President Obama. This new federal law contains hundreds of new provisions that are intended to address some of the perceived abuses within the financial services industry that contributed to the economic crisis in recent years. Given the complexity of the Act, it will be some time before the implications of the new law and regulations are fully realized.

This advisory summarizes only certain key aspects of the Act that specifically affect companies that file periodic reports with the Securities and Exchange Commission (SEC). In addition, see the separate advisories that summarize key changes specifically affecting community banks and mortgage brokers, lenders and servicers.

  • Relief from Section 404(b) of Sarbanes-Oxley for Non-Accelerated Filers. Non-accelerated filers (which generally includes SEC-reporting companies with a public float of less than $75 million) are exempt from the requirement in Section 404(b) of the Sarbanes-Oxley Act to obtain an auditor attestation of management’s assessment of the effectiveness of the company’s internal controls over financial reporting. This exemption is effective immediately. In addition, the SEC has been directed to study and report on potential ways to reduce the burden of complying with Section 404(b) on companies with a market capitalization of between $75 million and $250 million. This report is due by March 2011.
  • Proxy Access. Pursuant to authority granted under the Act, on August 25, 2010, the SEC adopted new Rule 14a-11, which will require any company that is subject to the SEC’s proxy rules to include shareholder nominees to the Board of Directors in the company’s proxy materials. Application of Rule 14a-11 to “smaller reporting companies” will be deferred for three years. The inclusion of shareholder nominees in the company’s proxy materials will not be required if the nominees are otherwise prohibited by the company’s governing documents or applicable state law. The number of such shareholder nominees that a company will be required to include in it’s proxy materials will be limited to the greater of one director or 25% of the number of directors on the company’s Board. To be eligible to nominate directors for inclusion in a company’s proxy materials, a shareholder (or group of shareholders) will be required to satisfy the following requirements:
    1. The shareholder(s) must own at least 3% of the total voting power of the company’s securities that are entitled to be voted at the election of directors at the meeting. Shareholders will be able to aggregate holdings to meet this threshold.
    2. The shareholder(s) will be required to have held their shares for at least three years and will be required to continue to own at least the required amount of securities through the date of the meeting at which directors are elected.
    3. The shareholder(s) will not be eligible to use the rule if they are holding the securities for the purpose of changing control of the company or to gain a number of seats on the Board of Directors that exceeds the number of nominees a company is required to include under new Rule 14a-11.
    4. The shareholder(s) will also be subject to a number of notice and procedural requirements.

The SEC also amended Rule 14a-8(i)(8), which will now require the inclusion of shareholder proposals that would amend or request an amendment to a company’s governing documents regarding a shareholder’s right to nominate directors or that relate to other disclosure or procedural matters concerning that nomination right, so long as the proposals do not conflict with applicable law (including proposed Rule 14a-11).

  • Mandatory Say-on-Pay Vote. Companies are now required to include a separate resolution in their proxy statements for annual shareholder meetings to solicit a non-binding shareholder vote to approve the compensation of the company’s executive officers. This non-binding vote must take place at least once every three years. In addition, at least once every six years, companies must have a separate non-binding resolution as to whether the say-on-pay vote should occur every one, two, or three years. The say-on-pay vote requirement will be effective for a company’s first shareholder meeting held on or after January 21, 2011. No SEC rules are required for implementation of the say-on-pay vote requirement, but the SEC is expected to issue rules with respect to the requirement that companies submit for shareholder vote the question of how frequent such say-on-pay votes should occur. The SEC has the authority to exempt smaller companies from these rules.
  • Golden Parachute Disclosure and Vote. Companies seeking shareholder approval for an M&A transaction must disclose in their proxy statement, in clear and simple language, any agreements or understandings with any of its named executive officers concerning any type of compensation that is based on or otherwise relates to the transaction, as well as the total of all such compensation that each such executive officer may receive. In addition, the proxy statement must include a separate resolution subjecting that transaction-based compensation to a non-binding shareholder vote. However, a separate “say on golden parachute” vote is not required for an arrangement that has already been subject to a shareholder vote under the “say on pay” requirement. These rules are effective for any such shareholder meeting held on or after January 21, 2011. The SEC is required to issue rules to implement this requirement, but is under no deadline to do so. The SEC has the authority to exempt smaller companies from these rules.
  • Additional Limits on Broker Discretionary Voting. Brokers will no longer have the ability to exercise discretionary voting (i.e., voting a client’s shares without receiving specific voting direction from the client) with respect to the election of Board members, executive compensation, and “any other significant matter.” Because the Act prohibits discretionary authority with respect to “executive compensation,” this presumably will prohibit discretionary voting on the say-on-pay and golden parachute shareholder votes described above. The SEC is required to oversee the adoption of rules by the national securities exchanges to implement this change, but is under no deadline to do so.
  • Additional Proxy Disclosure – Executive Compensation. Additional disclosure will be required in a company’s proxy statement regarding executive compensation. The additional disclosures include the relationship between pay and performance at the company and the ratio of the median annual total employee compensation to the CEO’s compensation. The SEC is required to issue rules to implement these disclosure requirements, but is under no deadline to do so.
  • Additional Proxy Disclosure – Hedging Policy. Companies will also need 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 equity securities granted to such employee or board member as part of the compensation of the employee or board member or held directly or indirectly by such employee or board member. The SEC is required to issue rules to implement these disclosure requirements, but is under no deadline to do so.
  • Additional Proxy Disclosure – Chairman/CEO Functions. Under new Exchange Act Section 14B, companies will be required to disclose in their annual proxy statements why the company has chosen the same person or different persons to serve as Chairman and CEO. The SEC is required to issue rules to implement this disclosure requirement by January 21, 2011.
  • Regulation FD Changes. The SEC is required to issue rules by approximately October 21, 2010, that removes the exemption from Regulation FD that allows disclosure of nonpublic material information to credit rating agencies.
  • Whistleblower Rules and Investor Protection. The Act further expands existing securities laws to create incentives for the public to provide information directly to the SEC that leads to successful enforcement proceedings. As an additional measure to protect and assist investors, the Act creates an Investor Advisory Committee within the SEC, an Office of Investor Advocate, and an Ombudsman. The Act’s whistleblower and investor protection provisions emphasize the need for good internal controls and attention to compliance issues. The provisions may lead to hard decisions regarding self-reporting violations.
  • Aiding and Abetting Liability. The Act provides that recklessness, in addition to knowledge, will satisfy the mental state requirement for securities laws violations. The Act also gives the SEC specific authority to bring enforcement actions against persons who aid and abet violations of securities laws
  • Shorter Reporting Deadlines. The Act amends the Exchange Act to permit the SEC to shorten the current 10-day reporting period for an acquisition of greater than 5% of a public company’s registered shares on Schedule 13D or 13G and an acquisition of greater than 10% of certain classes of registered securities, or the fact that a person has become an officer or director of a public company.

Additional Changes Affecting NYSE- and NASDAQ-Listed Companies

  • Compensation Committee Independence. New rules will be issued by July 21, 2011, that impose additional independence requirements on compensation committees. The rules will be required to give companies a reasonable opportunity to cure any defect before being subject to delisting procedures. It is possible smaller issuers could be made exempt from these additional independence requirements.
  • Compensation Committee Advisors. New rules will require compensation committees to consider a list of independence related factors to be identified by the SEC prior to selecting a compensation consultant, legal counsel, or other advisor. These rules are required to be issued by July 21, 2011. The rules will be required to give companies a reasonable opportunity to cure any defect before being subject to delisting procedures. It is possible smaller issuers could be made exempt from these additional independence requirements.
  • Clawback Policy. New rules will require companies to adopt and maintain a policy requiring the clawback of certain incentive-based compensation from current and former executive officers if the company is required to prepare any accounting restatement due to material noncompliance with financial reporting requirements. No deadline was imposed for the implementation of these new rules.

Please contact your Varnum attorney for more information.

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