US federal proxy rules and executive compensation



Alexandra R. Lajoux of the National Association of Corporate Directors (NACD) moderates a discussion between Douglas P. Long at Faegre & Benson LLP, Thomas Ball at Morrow & Co., LLC and Michael J. Levitin at Wilmer Cutler Pickering Hale and Dorr LLP, on proxy rules and executive compensation in the US.

Lajoux: On 25 August this year, the SEC passed a vote to facilitate shareholder director nominations through issuer proxy statements. What were the reasons behind this rule change?

Long: The SEC has long recognised that nomination and election of directors is a principal way that shareholders can hold boards accountable and influence matters of corporate policy. For years the SEC has been concerned that the federal proxy rules and processes unnecessarily frustrated the exercise of these critical state law rights by shareholders. By adopting new Rule 14a-11, the SEC hopes to facilitate shareholders’ ability to exercise their rights to nominate and elect directors – leading to more accountable, responsive, and effective boards. Detractors of proxy access are not buying this. Those opposed to proxy access fear that it will continue the slide to a ‘short-termism’ attitude, encourage activist shareholders to advance narrow agendas, increase the costs of corporate elections, and ultimately weaken the effectiveness of boards.

Ball: Proxy access has been the Holy Grail of corporate governance activists for almost a decade. In 2002, the American Federation of State, County and Municipal Employees (AFSCME) embarked on a vigorous, post-Enron shareholder activism campaign; submitting shareholder proposals on a range of issues, including a new proposal that would allow shareholders’ access to the proxy statements to nominate and elect directors they have chosen. At the time, AFSCME President Gerald McEntee stated, that the proposals are “based on the democratic principle that, as owners, shareholders are entitled to a meaningful choice in elections for directors”. In the intervening years, this desire for choice in the election of directors has led activists to pursue the right to proxy access in the courts, through shareholder proposals, and by applying consistent pressure on the SEC. Finally, after an extended period of rule making and comments from investors, the SEC approved proxy access this past August.

Levitin: Let me provide a historical perspective. The proxy access rules derive from three long-term trends. First is the separation of management and ownership. A modern industrial economy cannot function unless businesses mobilise large amounts of capital. But even by 1932, when Berle and Means published The Modern Corporation and Private Property, it was apparent that the interests of managers and owners were not perfectly aligned. Second, over the last 78 years, an extraordinary amount of wealth has been created in this country, households have increasingly invested through mutual funds, and pension funds hold an increasing share of workers’ retirement savings. Ownership in public companies is now increasingly concentrated in large, sophisticated institutional investors. Third, the technology that transformed the economy also made it much easier for stockholders to communicate with each other, and with boards and management. These trends prompted numerous changes in SEC rules over the past several decades. Among many changes, the SEC adopted rules facilitating communications among stockholders, and requiring companies to disclose whether they will consider director-candidates recommended by stockholders. Now comes the greatest economic crisis since Berle and Means’ first edition. The crisis led many to ask whether directors were sufficiently accountable and responsive to the interests of stockholders. Directors play a critical role in our system of corporate governance: they are fiduciaries for stockholders and oversee management and the corporation. The SEC considered variations of proxy access in 1942, 1977, 1992, 2003, and 2007. In view of historical trends, the importance of the board, and mid-crisis questions about whether boards are appropriately focused on stockholders’ interests and are sufficiently accountable for their decisions on matters such as compensation and risk-management, some form of proxy access was likely inevitable. 

Lajoux: The Business Roundtable and the Chamber of Commerce recently sued the US Securities and Exchange Commission in federal court, seeking to overturn the ‘proxy access’ rules. Can you outline the nature of their objection and the immediate implications for companies?

Ball: As a result of the litigation, the SEC has issued a stay on the effective date of 14a-11 (proxy access) and there is not likely to be any proxy access for the 2011 proxy season, and it may not be until the 2012 proxy season that we see proxy access in effect. As a result, companies have been afforded a reprieve and do not need to take immediate action in response to proxy access. However, companies may want to use this time to review their compensation and corporate governance practices, as well as their bylaws.

Levitin: The Business Roundtable and the Chamber of Commerce (‘petitioners’) claimed that the SEC’s decision to adopt the proxy access rules was ‘arbitrary and capricious’ – a term of art under the Administrative Procedures Act – because the SEC did not adequately assess the rules’ effect on efficiency, competition, and capital formation, as required by the Securities Exchange Act and Investment Company Act. In support of this claim, the petitioners argue that the SEC underestimated the costs and overestimated the benefits from proxy access, and also that the SEC “gave inadequate weight to the motives and intensity of nominating shareholders”. (The petitioners asserted that union-related investment funds will be among the more active users of proxy access and that these funds “act for reasons other than maximising the value of their investment”.) The petitioners also claim that the rules violate the rights of corporations under the First and Fifth Amendments to the US constitution. In response to this suit, the SEC stayed the effectiveness of the proxy access rules. For companies with fiscal years ending 31 December, the immediate implication is that the proxy access rules will likely not be effective for their 2011 annual meetings.

Long: The Business Roundtable and the US Chamber of Commerce have long argued that proxy access is bad public policy. But they, along with others opposed to proxy access, appear to have lost that battle with the adoption of Rule 14a-11 on a sharply divided 3-2 vote of the Commissioners. They are now seeking to overturn Rule 14a-11 on legal grounds, arguing that it is arbitrary and capricious, violates the Administrative Procedure Act – and contending that the SEC failed to properly assess the Rule’s effects on “efficiency, competition and capital formation”, as required by law. The suit asserts that the SEC erred in appraising the costs of proxy access, ignored evidence highlighting adverse consequences, and muddled the application of federal and state law to the nomination and election process. While strongly disagreeing with the assertions in the suit, the SEC did agree to stay Rule 14a-11 (and the companion amendments adopted to Rule 14a-8) until resolution of the case. However, even with expedited court review, it is highly unlikely that the new rules will be effective for the spring 2011 proxy season.

Lajoux: What response, if any, should companies make in preparation for the 2011 proxy season?

Levitin: Companies should monitor the proxy access litigation and any related rule-making, so that they can be prepared to act, once the court issues its decision. Beyond that, companies should take advantage of the stay, to prepare for a system in which long-time stockholders have the right to include their own nominees in the company’s proxy materials. Companies could assess their stockholder base, consider issues that their stockholders have previously raised, and evaluate whether those issues can reasonably be addressed. Companies could also assess their corporate governance in light of evolving best practices. It’s important to remember that nomination is not equivalent to election: stockholders may be able to nominate candidates, but those candidates won’t join the board unless they are elected. Companies may be able to preempt nominations or mitigate the risk that a stockholder-nominee will be elected by improving their governance practices, addressing concerns that stockholders have raised, and ensuring that they have first-class directors.

Long: While Rule 14a-11 may not be effective for the Spring 2011 proxy season, activist and other institutional shareholders will certainly still be around. Shareholders who hope to influence boards and company policies still have access to traditional proxy contests, shareholder proposals under existing Rule 14a-8, ‘vote no’ campaigns, and other tactics. Companies need to continue to engage their shareholders to make sure they understand their shareholders’ concerns and to ensure shareholders clearly understand not only the company’s strategic plan, but also its governance and compensation philosophies and policies. The goal, if at all possible, should be to address and diffuse shareholder issues before they evolve into costly and time-consuming public battles.

Ball: Companies may want to take the time now to review their compensation and governance practices since the initial targets of proxy access are likely to be underperforming companies that also have compensation and corporate governance vulnerabilities, such as single-trigger change-in-control provisions, tax gross-ups, or excessive executive perks, or companies that have gotten high votes against Say-on-pay proposals, high withhold votes on directors, or majority support on shareholder proposals and have not taken ‘corrective’ action. To the extent that you can take a measured approach to correct weaknesses or begin the process of taking action on them, you may become less vulnerable. In addition, this would be an ideal time to review (in conjunction with your law firm) your bylaw provisions such as advance notice and director qualifications, since issuers have the luxury of time to make sure they get it right (and language is important, in light of recent court rulings).

Lajoux: The US Dodd-Frank Act, introduced earlier this year, contains provisions for a ‘say-on-pay’ vote. How will this development affect shareholder involvement in compensation decisions?

Long: In 2011, shareholders will vote for or against a company’s executive compensation in total, as disclosed in the CD&A, tables, and the accompanying narrative included in a company’s proxy statement. The future frequency of such votes will also be on the ballot for 2011 annual meetings, with shareholders being able to express their preference for such a vote every one, two, or three years. Both votes will be non-binding. The SEC has just recently published proposed rules regarding the newly required votes and related disclosure matters. The spectre of a significant percentage of votes against its executive compensation practices and policies will provide shareholders with additional leverage in their discussions with companies. Threats to vote no can be used by shareholders to try to force a specific executive compensation change or even a change in some company strategy or policy wholly unrelated to compensation. And a company could face a multitude of these threats from different shareholders, each with its own agenda.

Ball: Say-on-pay votes provides shareholders with a vehicle to express dissatisfaction with compensation. Unfortunately, say-on-pay is a blunt instrument. A vote against say-on-pay does not provide guidance to a company as to what it is about its compensation scheme that shareholders do not like. Some shareholders may be objecting to the sheer amount of compensation, while others may be using say-on-pay to criticise the company’s rationale for compensation rather than the dollar amount. Because of the imprecise nature of the say-on-pay, companies receiving high votes against may feel compelled to involve shareholders in the process by reaching out to their larger institutional holders to learn the reasons for their against vote and then consider this feedback in their compensation decisions. And, if issuers have had negative feedback from investors in the past about compensation, they should be reaching out to investors now.

Levitin: The Dodd-Frank Act requires public companies to have a separate, non-binding vote on the compensation of their executives, effective with their first stockholder meeting on or after 21 January 2011. That’s the say-on-pay vote. Although the resolution is non-binding, companies will want a favourable vote from a substantial majority of their stockholders. Losing a say-on-pay vote could have wider consequences. At a minimum, if a company say-on-pay proposal does not receive majority support, and if the company does not revise its compensation practices in response, the company may face votes against or withheld from directors in subsequent years. If the company has a majority vote standard for uncontested elections, as an increasing number of companies do, significant votes against or withheld could trigger a director’s resignation. The net effect of this is to increase stockholders’ influence over compensation decisions.

Lajoux: What steps do companies need to take in light of the compensation changes brought under Dodd-Frank?

Ball: The SEC has released a tentative schedule for implementation of the Dodd-Frank Act. Based on this schedule, disclosure of pay-for-performance, pay ratios, hedging by employees and directors, and compensation consultant conflicts will not be required in proxy statements for meetings during the 2011 proxy season. For 2011 though, companies are required to offer a say-on-frequency vote – issuers must include a non-binding proposal on the agenda giving shareholders a choice of whether future say-on-pay votes should be submitted to shareholders every one, two or three years. Companies will have to make a decision on the Frequency recommendation based on their particular shareholder profile and their compensation and governance practices. Companies seeking a biennial or triennial Frequency vote will need a persuasive argument as to why these timeframes work for their particular circumstances, such as explaining how a biennial or triennial vote corresponds with the company’s compensation scheme.

Long: Dodd-Frank contains a number of other compensation-related mandates, ranging from requiring independent compensation committees and advisers to requiring additional disclosures chronicling the relationship between executive compensation actually paid and the company’s financial performance. However, all of these mandates require further rulemaking for implementation – and such rulemaking is unlikely to be in place for the spring 2011 proxy season. While the new rules are not yet in force, the importance of executive compensation to the SEC, and to shareholders, is not in question. Companies should continue to review and evaluate their compensation practices and policies to make sure they adequately and accurately reflect compensation goals, inventory any existing clawback and hedging policies, and review previous compensation-related disclosures to make sure the communication is clear and understandable. Companies should be aware of any compensation policies that may raise red flags at the various proxy advisory firms or that conflict with the stated compensation policies of institutional shareholders.

Levitin: With respect to say-on-pay, companies should consider action in three areas. First, public companies should identify (and evaluate whether to change) existing compensation policies that investors are highly critical of, such as those embodied in ISS’ list of problematic pay practices. Second, companies should consider implementing compensation practices that investors deem ‘best practices’, such as stock ownership, stock retention, and clawback policies. Third, companies should identify ways to enhance the CD&A section of their proxy statements so that it better communicates the company’s story. These enhancements might include: adding an executive summary; focusing the executive summary on the specific relationship between pay, financial performance, and the company’s business strategy, and making the summary more of an advocacy piece, rather than just an introduction or a pure summary; making the discussion of performance goals and the relationship of compensation to the achievement of performance goals more transparent; using more charts and graphics; and shortening CD&A by deleting immaterial information and moving detailed descriptions elsewhere in the proxy statement. Say-on-pay is only one of several compensation-related changes effected by the Dodd-Frank Act. Public companies will also want to consider the new laws and regulations governing say-on-frequency, say-on-parachutes, compensation consultants and advisors, the authority of the compensation committee, and independence standards for that committee’s members. 

Lajoux: On 9 September 2010, the SEC approved an amendment to NYSE Rule 452 which eliminates broker discretionary voting on all compensation related proposals, including ‘say-on-pay’. Could you explain the potential impact of this development for listed companies?

Levitin: NYSE Rule 452 previously permitted brokers to vote ‘uninstructed shares’ on some compensation-related proposals, including say-on-pay. These were ‘broker discretionary votes’. The amendment to Rule 452 means that brokers will only be able to vote shares on compensation-related proposals if they receive voting instructions from the shares’ beneficial owners. Historically, retail holders were much less likely than institutional holders to provide voting instructions, and a very high percentage of broker discretionary votes supported the company’s recommendations. The amendment to Rule 452 effectively eliminates a pool of votes on which companies previously relied. Because of the implications for companies of not receiving a majority vote in favour of their pay practices, companies will need to have appropriate strategies to communicate with their stockholders and solicit their votes. This may require a more active level of communication and solicitation than in prior years. 

Long: Until recently, brokers holding shares in street name who did not receive specific voting instructions from the beneficial owners of the shares could vote those shares in their discretion on routine matters. Historically, brokers and other holders of retail shares have tended to follow the recommendations of management in voting. But with the recent rule changes, director elections and compensation matters are no longer considered routine matters for which brokers can exercise discretionary voting authority. Getting retail holders, often with few shares, to provide voting instructions to brokers can be difficult. If these shares are not voted, this will likely increase the impact of the votes of institutional holders – potentially providing them with additional negotiating leverage.

Ball: The impact of the elimination of the broker discretionary voting on say-on-pay proposals will vary depending on a company’s shareholder profile. For companies with a large number of shares held in broker name, the loss of the discretionary vote may mean lower favourable votes on say-on-pay as a percentage of the voted shares, since a negative institutional vote will be magnified with the reduced turnout. Companies should be knowledgeable about their shareholder profile and assess the impact of the loss of the broker vote so that senior management and the board can be apprised if the loss of the broker vote makes them significantly more vulnerable to a possible negative result. Companies concerned with the implications of a relatively high vote against say-on-pay may want to consider additional solicitation measures, such as targeted mailing and phone calls, to boost the overall vote from holders in broker name.

Lajoux: Overall, can companies expect to see greater shareholder influence in board appointments and executive compensation decisions going forward? In your opinion, will this improve the existing corporate governance framework or disrupt companies from executing their strategies?

Ball: With regard to executive compensation, I can see shareholders having greater influence going forward. For example, companies that have a say-on-pay proposal fail or receive high against votes, face the prospect of shareholder action at their next annual meeting (such as withhold votes on directors, or a shareholder proposal), unless some sort of ‘corrective’ action is taken. What that action is will depend on the specifics of the vote, the shareholder profile, and the company’s overall corporate governance.  As to the disruption, the new requirements of Dodd-Frank increase the workload of boards and managements. At some point, there is the possibility that companies will be spending too much time on compliance and not enough time on running the business and making money for shareholders. And, if proxy access becomes a reality, there is no doubt that shareholders will enjoy greater influence in future board appointments.

Long: Clearly, these changes will provide shareholders with additional leverage in their discussions with companies and boards. If used constructively, the rules could serve as impetus for improving corporate governance at many companies – increasing communication between shareholders and companies and prompting companies to voluntarily adopt governance best practices. But ultimately, I fear that activist shareholders will be tempted to use these tools to advance narrow or short-term agendas not in the best interests of the majority of shareholders. In addition, the new rules could make it more difficult to recruit and retain directors and may divert company time and resources away from the management and operation of the business.

Levitin: As the NYSE commission on corporate governance recently stated, “Good corporate governance includes transparency for corporations and investors … and communication … through dialogue and engagement as necessary and appropriate”. And as the commission noted, “The board’s fundamental objective should be to build long-term sustainable growth in shareholder value for the corporation”. In pursuing that objective, directors have significant information about a company’s strengths, weaknesses, opportunities, and threats, and directors are responsible for using their judgment. It would certainly be possible for stockholders to provide input on executive compensation and board composition in ways that were disruptive. It’s also possible to envision approaches that were constructive and that increased the welfare of all stockholders. Whether stockholders’ increased influence is more disruptive or constructive will ultimately depend on how stockholders use that influence. Having begun with a nod to a book published in 1932, let me end with a quotation from Franklin Roosevelt’s last state of the union address: “In a democratic world, as in a democratic nation, power must be linked with responsibility.”


Alexandra R. Lajoux is chief knowledge officer at the National Association of Corporate Directors (NACD). She has three decades of experience in business information. Widely published and quoted in professional publications, Ms Lajoux has authored or co-authored five books on mergers and acquisitions for McGraw-Hill, and one book on valuation for Bloomberg. She has served on several non-profit and advisory boards. She can be contacted on +1 (202) 280 2185 or by email:

Douglas P. Long is a partner at Faegre & Benson LLP. He has practiced with the corporate finance group at Faegre & Benson since 1984 and has been a partner since 1991. Mr Long focuses primarily in the areas of securities reporting and regulation, public and private financings, public and private mergers and acquisitions, corporate governance, and general corporate counselling to a variety of publicly and privately held clients. He can be contacted on +1 (612) 766 7212 or by email:

Thomas Ball is a senior managing director with Morrow & Co, LLC, head of the Proxy Solicitation Group at Morrow & Co., and co-head of the Special Situations Group. He has 30 years of experience in the proxy solicitation business, with extensive experience in corporate control transactions and corporate governance. Mr Ball has provided strategic counsel and directed many high-profile hostile fights, both defending corporate clients and forwarding the objectives of dissident groups. He has also appeared as an expert witness in Delaware Chancery Court. He can be contacted on +1 (203) 658 9400 or by email:

Michael Levitin is a partner in the corporate group of Wilmer Cutler Pickering Hale and Dorr LLP, resident in the firm’s Washington DC office.  His practice focuses on mergers and acquisitions, corporate finance, contests for corporate control, and general corporate matters, including corporate governance.  Mr Levitin is also an adjunct professor at Georgetown University Law Center, where he teaches the international mergers & acquisitions seminar.  He can be contacted on +1 (202) 663 6163 or by email:

© Financier Worldwide



Alexandra R. Lajoux

National Association of Corporate Directors (NACD)


Douglas P. Long

Faegre & Benson LLP 


Thomas Ball

Morrow & Co., LLC


Michael J. Levitin

Wilmer Cutler Pickering Hale and Dorr LLP

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