Article

Wall Street Reform or Over-Regulation?

What the Dodd-Frank Wall Street Reform and Consumer Protection Act Means for Public Companies

Well more than a year after the onslaught of the greatest financial crisis since the Great Depression which caused the failure of Wall Street icon Lehman Brothers and brought to light numerous scandals such as the Bernie Madoff Ponzi scheme, Congress has finally acted on the promise of financial regulatory reform. The massive law, known as the Dodd-Frank Wall Street Reform and Consumer Protection Act is designed to cure the country’s economic woes, reel in Wall Street, protect consumers, create a sound economic foundation to increase jobs, and prevent another financial crisis. This legislation was signed into law by President Obama on July 21, 2010.[1] The new legislation requires sweeping changes to the regulatory landscape for public companies, banks, insurance companies and hedge funds, as well as other financial services companies. It also establishes a new regulatory structure and reorganizes the existing structure governing a broad range of financial services and other companies.

The new legislation also addresses systemic risk in the financial system and the issue of financial institutions that are considered “too big to fail” through the creation of a Financial Stability Oversight Council. The new legislation implements a laundry list of corporate governance requirements including shareholder advisory votes on executive compensation matters, proxy access and mandatory clawback provisions in employment agreements as a condition to an exchange listing. All of this regulatory reform comes with a huge price tag—estimated to come in around $18 billion, but who’s counting?

The proposed legislation is far reaching and includes numerous detailed provisions as emphasized by the 2,300 page conference report released on June 30, which will require over 200 additional rule-makings by approximately 11 different federal agencies, as well as over 60 studies and 20 reports,[2] in order to implement, and which will take approximately two years. As a result, the full effect of this legislation on public companies will not be determined for several years. Of these requirements, the Securities and Exchange Commission (SEC) will bear the largest burden of the regulatory reform. The SEC will be required to initiate approximately 95 of these rule-makings, in addition to 17 studies and 5 new periodic reports. [3] When you add all this up, it means the regulators, primarily the SEC, are going to be extremely busy over the next two years. However, what is in store for public companies remains to be seen. Given these numbers, one has to ask if this legislation is going to “better” regulate or “over-regulate” public companies?

This article highlights certain of the more significant changes in the new legislation that will affect public companies based upon the Joint House Senate Conference Report approved on June 30 by the House of Representatives, and on July 15 by the Senate.[4]

Highlights of the New Legislation

Addressing Systemic Risk and the Creation of the Financial Stability Oversight Council
The 2008 financial crisis and the related demise or financial woes of several large financial institutions, like Lehman Brothers and AIG, highlighted the need to mitigate systemic risk and the “too big to fail” concept. As a result of these perceived failures in the current regulatory scheme, the Act includes the establishment of the Financial Stability Oversight Council, a new governmental agency charged with identifying and managing emerging risks throughout the financial system. This agency will be chaired by the Secretary of the Treasury and consist of representatives from, among others, the Federal Reserve Board (FRB), the SEC, the Commodity Futures Trading Commission, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation (FDIC), the Federal Housing Finance Agency, the National Credit Union Association and the newly created Consumer Financial Protection Bureau. This Council will have the authority to designate nonbank financial companies which are subject to FRB regulation if the Council determines that material financial distress at such entity or the nature, scope, size, scale, concentration, inter-connectedness or mix of such entities’ activities could pose a threat to the country’s financial stability.

Creation of the Bureau of Consumer Financial Protection
A new Bureau of Consumer Financial Protection will be created to enforce consumer protection laws and adopt rules against unfair, deceptive or abusive practices in the financial services industry. This new Bureau will have broad powers to regulate financial services providers, regardless of whether the entity is associated with an insured bank. This new Bureau will consolidate the consumer protection responsibilities currently handled by the federal banking agencies, as well as the U.S. Department of Housing and Urban Development and the Federal Trade Commission, and regulate and examine banks and credit unions with assets of more than $10 billion, and all large mortgage related businesses, such as mortgage brokers, services and debt collectors.

Corporate Governance Reforms
The new legislation imposes several corporate governance requirements applicable to companies listed on U.S. stock exchanges and to a lesser extent, other publicly-traded companies. These requirements include, among other things:

• a requirement for a non-binding shareholder advisory vote on executive compensation of specified officers in annual and special meeting proxy statements and golden parachute provisions in proxy statements where shareholders are asked to approve the related merger, acquisition or other transactions that triggered the payment; 
• a provision authorizing the SEC to adopt rules on proxy access; 
• a prohibition on discretionary voting by brokers on a shareholder vote in connection with the election of directors, executive compensation or other significant matters; and 
• additional disclosure on executive compensation.

Creation of the Financial Stability Oversight Council; Addressing the ‘Too Big to Fail’ Concept and Ending Federal Bailouts of Large Financial Institutions

Establishment and Role of the Council—The Council is one of the key creations of the new legislation, which likely represents one of the most significant reforms in the Act. The Council has broad authority to identify and respond to risks to the financial stability of the U.S. that could arise from the material financial distress or failure, or other activities, of large bank holding companies or “nonbank financial companies”[5] such as insurance companies, broker dealers and asset management companies. The broad duties of the Council include, among other things:

• monitoring the financial marketplace in order to identify potential threats to identifying gaps in regulation that could pose risks to the financial stability of the U.S.;
• requiring supervision of nonbank financial companies by the FRB that may pose risks to the financial stability of the U.S. in the event of their material financial distress or failure; 
• making recommendations to primary financial regulatory agencies to apply new or heightened standards and safeguards for financial activities or practices that could create or increase risks of significant liquidity, credit, or other problems spreading among bank holding companies, nonbank financial companies, and U.S. financial markets; and
• making recommendations to the FRB concerning the establishment of heightened prudential standards, and reprinting and disclosure requirements for risk-based capital, leverage, liquidity, continent capital, resolution plans and credit exposure reports, concentration limits, enhanced public disclosures, limits on short term debt and overall risk management for nonbank financial companies and certain large bank holding companies (institutions with assets of more than $50 billion) supervised by the FRB. These standards would be more stringent than those applicable to other nonbank financial companies and bank holding companies that do not present similar risks to the financial stability of the U.S.

FRB Regulation of Nonbank Financial Companies—The Council, on its own initiative or at the request of the FRB, can determine that a U.S. or foreign nonbank financial company shall be regulated by the FRB and subject to the Council’s more stringent regulatory standards described above. The legislation sets out specific criteria for determining whether a U.S. or foreign nonblank financial company is subject to supervision by the FRB. This means that financial companies that were largely unregulated before will be subject to stringent bank holding company regulatory requirements. Further, any entity that became a bank holding company with assets of $50 billion or more, as of January 1, 2010, that received TARP funds and that ceased to be a banking holding company after January 1, 2010, may be treated as a nonbank financial company supervised by the FRB, as determined by the Council. The FDIC was also provided with special examination authority over these nonbank financial companies with total assets equal to or greater than $50 billion, if determined necessary by the FDIC.

Risk Committees Requirements—In addition, the FRB must require each publicly-traded bank holding company with total consolidated assets of $50 billion or more and each nonbank financial company to establish a risk committee within the timeframes set out in the statute. The risk committee to be responsible for the oversight of the enterprise-wide risk management practices of the nonbank financial company supervised by the FRB or a bank holding company with total consolidated assets equal to or greater than $50 billion. The committee must include such number of independent directors as the FRB may determine appropriate, based on the nature of operations, size of assets, and other appropriate criteria related to the nonbank financial company supervised by the FRB or a bank holding company with total consolidated assets of $50 billion or more. The risk committee must include at least one risk management expert having experience in identifying, assessing and managing risk exposures of large, complex firms. The FRB must adopt these rules not later than two years after the enactment of this legislation and such rules must take effect within 15 months of such date.

It is likely that affected companies will elect early adoption of this risk committee and revise its composition once final rules are adopted by the FRB. This requirement will essentially be a full employment act for enterprise risk management consultants. Many public companies may also consider adopting this type of committee as a best practice even if they are not initially subject to these requirements.

Annual Stress Test Requirements for Financial Companies; Limits on Proprietary Trading and Ownership of Hedge Funds; and Addressing the “Too Big to Fail” Problem—In addition, all financial companies with total consolidated assets of more than $10 billion and regulated by a primary federal regulatory agency must conduct an annual stress test. Additionally, under the new legislation, subject to certain exceptions, any nonblank financial company supervised by the FRB that engages in proprietary trading[6] or retains an ownership stake in a hedge fund or private equity fund will be subjected to additional capital requirements, as well as limits on these activities. This provision of the Act has been referred to as the “Volcker Rule”.[7] The final version of the Volcker Rule which was watered-down from its original form allows banks and nonbank financial companies regulated by the FRB to invest up to 3% of their Tier 1 capital in private equity and hedge funds but prohibits these entities from acquiring more than 3% in a hedge fund or private equity fund. The implementation of this section requires action by the banking regulators, which regulations must be in place within two years of enactment of the Act. The affected entities have two years after that to achieve compliance with these requirements. In addition, subject to limited exceptions, bank holding companies and nonblank financial companies regulated by the FRB will be prohibited from acquiring the assets of or merging with other companies if the resulting company’s total consolidated liabilities would exceed 10% of the total consolidated liabilities of all financial companies at the close of the preceding calendar year.

The Act also restricts the emergency powers of the FRB which were utilized during the financial crisis to provide temporary credit which resulted in scrutiny from Congress as well as the public. The Act places several restrictions on the FRB’s ability to use the powers contained in Section 13 of the Federal Reserve Act.[8] Under the Act, the FRB’s ability to utilize its emergency lending authority is limited to participants in programs that have “broad-based”[9] eligibility. These programs also require prior approval of the Secretary of the Treasury. Additionally, any institution that receives assistance will have to provide specific collateral to secure the loan. This provision is intended to protect tax payers from having to “bailout” failing institutions. The downside of these provisions is the FRB’s ability to act quickly in a time of crisis will be more difficult.

Investor Protection and Improvements to the Regulation of Securities

Additional New Offices Within the SEC Will Likely Lead to New Regulatory Initiatives—The new legislation establishes an Investor Advisory Committee within the SEC to advise the SEC on its regulatory priorities, issues related to the effectiveness of securities disclosure, the regulation of securities products, fee structures and trading strategies.[10] The Investor Advisory Committee will also advise and consult with the SEC on initiatives to protect investor interests and to promote investor confidence and the integrity of the securities marketplace. The committee will submit its findings and recommendations to the SEC, including recommendations for proposed legislative changes. The SEC established the Investor Advisory Committee in June 2009 with a similar mission, including advising the SEC on matters of concern to investors in the securities markets; providing the SEC with investors’ perspectives on current, non-enforcement, regulatory issues; and serving as a source of information and recommendations to the SEC regarding its regulatory programs from the point of view of investors. The Act has provided express authority for the creation of this committee.

The legislation also establishes the Office of Investor Advocate within the SEC to assist retail investors in, among other matters, resolving significant problems with the SEC or the securities exchanges, to identify areas where investors will benefit from changes in SEC regulations or exchange rules and to propose appropriate rule changes to the SEC or Congress.

The creation of these new offices within the SEC can only mean one thing—more regulation is coming.
 

Changes to the Private Offering Exemptions in Regulation D—Rules under the Securities Act of 1933 (the “Securities Act”) provide for a series of tests to determine whether an investor is an “accredited investor.” One common application of this test is to determine whether an investor is an “accredited investor” for purposes of Rule 506 of Regulation D, under which an unlimited amount of securities may be sold to an unlimited number of accredited investors. Under these current rules, an investor that is a natural person, either individually or together with the investor’s spouse, and who has a net worth of greater than $1 million at the time of the purchase, is deemed to be an accredited investor.[11] The legislation requires the SEC to amend any of the net worth standards to exclude the value of the investor’s primary residence from the calculation of net worth and to provide for a periodic adjustment of the $1 million threshold beginning four years after the date of the legislation’s enactment.[12] Reflecting this change should be of utmost importance to venture capital and private equity firms, which generally rely on Rule 506 of Regulation D to raise capital for their funds without having to register those transactions under the Securities Act. The law also authorizes the SEC to undertake a review of the accredited investor tests that apply to natural persons, other than the net worth standard, to determine whether the requirements of the definition should be adjusted in light of the public interest, the protection of investors and the economy. The SEC may make changes to the rule, other than the net worth standard, as it deems appropriate, taking these considerations into account.

Beginning four years after the date of the legislation’s enactment, and at least every four years thereafter, the SEC must review the definition of “accredited investor” set forth in Rule 215 under the Securities Act (or any successor rule) to determine whether the definition in its entirety should be amended for the protection of investors, in the public interest or in light of the economy. While the accredited investor test set forth in Rule 215 is identical in all material respects to the definition applicable to Rule 506 offerings, it is unclear whether the amendment of Rule 215 pursuant to the Dodd-Frank Act will affect the definition of accredited investor that is applicable to Rule 506 offerings.

Within one year after the Dodd-Frank law is enacted, the SEC must amend Rule 506 to include specified “bad boy” disqualifications for offerings exempt under that rule. First, the SEC must enact rules that provide for disqualifications under Rule 506 that are “substantially similar to” the provisions under Rule 262 of the Securities Act. Under Rule 262, an issuer is disqualified from relying upon that exemption if the issuer (or its predecessors or affiliated issuers), or its officers, directors, promoters, 10% or greater stockholders, or underwriters (and their affiliates) meet any one of several “bad boy” disqualifications. Generally speaking, these disqualifications apply if:

• the issuer has filed a registration statement within the last five years that has been subject to a stop order under the Securities Act;
• a covered person has been convicted within five years (10 years for persons other than the issuer) of any felony or misdemeanor in connection with the purchase or sale of a security, a false filing with the SEC, or other specified securities-related conduct;
• a covered person (other than the issuer) is subject to certain specified orders applicable to certain regulated persons under the securities laws, including the making of any false filing with the SEC;
• a covered person is or within the past five years (10 years for persons other than the issuer) has been subject to an injunction of court for specified securities-related conduct; and 
• a covered person (other than the issuer) is suspended, barred or expelled from association with a member of a stock exchange for any act in violation of just and equitable principles of trade.

In addition to these disqualifications, the legislation will require the SEC to adopt rules disqualifying an offering or sale of securities under Rule 506 if a person is subject to a final order of:

• a state securities commission;
• a state insurance commission; or
• a state or federal authority supervising banks, savings associations or credit unions, including the National Credit Union Administration;

that is issued within 10 years of the filing of the offer or sale and is based upon a violation of any law or regulation prohibiting fraudulent, manipulative or deceptive conduct, or that bars the person from:

• associating with any regulated entity;
• engaging in the business of securities, insurance or banking; or
• engaging in savings association or credit union activities.

Reliance on Rule 506 would also be barred for any person that has been convicted of any felony or misdemeanor in connection with the purchase or sale of any security or involving the making of a false filing with the SEC, no matter when the conduct occurred.

While Rule 262’s “bad boy” provisions had been currently applicable to offerings of securities under rarely-used Rule 505, the imposition of these requirements to Rule 506 offerings will serve to lessen the ability of some issuers to rely upon this widely-used exemption to raise capital. This amendment will also require an additional layer of due diligence for issuers relying upon Rule 506 in these transactions, especially necessitating deeper scrutiny into the background of the issuer’s controlling persons, 10% or greater beneficial owners, promoters, underwriters and related persons.

Incentives for Whistleblowers—The Act adds a new benefit to whistleblowers.[13] Under this new provision, subject to certain exceptions, the SEC will have the authority to pay to a whistleblower 10% to 30% of any money the SEC or another agency collects, if the whistleblower provides “original” information leading to an enforcement of a judicial or administrative action where the monetary sanctions recovered exceed $1 million.

Such payments will be in the SEC’s sole discretion. This provision does not apply to whistleblowers that are members or employees of a self regulatory organization (for example, a securities exchange), the Department of Justice, the Public Company Accounting Oversight Board or a regulatory or law enforcement agency. Additionally, a whistleblower will be denied an award if such whistleblower is convicted of a criminal violation related to the judicial or administrative action for which the whistleblower provided original information, or if the whistleblower gained the original information through the performance of the audit of the company’s financial statements. Whistleblowers will also receive payments if their information leads to a successful related action by another governmental agency. Additionally, the federal whistleblower protection provided by the Sarbanes-Oxley Act was extended to prohibit retaliation or discrimination by subsidiaries or affiliates of a public company. Under the Act, public companies, including their consolidated subsidiaries or affiliates, may not discharge, demote, suspend, threaten or otherwise discriminate against a whistleblower.

Enhanced Liability for Securities Violations—The legislation also expanded the Securities Act which governs securities offerings to add “aiding and abetting liability” for any person that “knowingly or recklessly” provides substantial assistance to another person in violation of the Securities Act. Section 20(e) of the Securities Exchange Act of 1934 (the 1934 Act) was amended to enhance the current “aiding and abetting” liability to include “reckless” acts.

New Short Sale Restrictions—The Act also requires the SEC to adopt rules requiring financial institutions to disclose information regarding short sales. Brokers will also be required to notify customers that such customers may elect not to allow their shares to be lent to third parties by the broker. Brokers are also required to notify their customers if the customers’ securities are used in short sales and indicate that the broker may receive a fee in connection with lending the customers’ shares. These are helpful provisions in that they enable retail brokerage customers to be put on notice of their rights with respect to the short sale of their securities held in brokerage accounts. Since excessive and prolonged short sales often have the effect of decreasing the market value of the affected publicly traded securities, investors holding such securities may want to limit these activities as being against their own economic interest. The new SEC rules may have the effect of reducing short selling problems haunting some public companies.

Accountability and Executive Compensation

The new executive compensation and corporate governance provisions of the Act apply to companies with securities listed on a national securities exchange, and in certain instances, to all companies subject to the SEC’s proxy rules—these companies are generally referred to as public companies throughout this article.

Say on Pay and Golden Parachute Proposals— The Act added Section 14A to the 1934 Act to require public companies to include, beginning six months after enactment, in their proxy statements related to all annual or special meetings for which the SEC proxy solicitation rules require compensation disclosure, a separate proposal seeking a shareholder vote on the compensation of certain executive officers. The shareholder vote on this proposal, which has been called a “say on pay” proposal, is non-binding and as a result does not override board decisions in this regard, does not create or imply any change to fiduciary duties of the board of directors, and will not preclude shareholder compensation proposals.[14] This requirement will be applicable without the need for any implementing regulations. In addition, at the first shareholders’ meeting to which this requirement will apply, each public company must include another shareholder proposal in its proxy materials which permits shareholders to determine the frequency of the inclusion of a “say on pay” proposal in its proxy materials (i.e., every year, every two years, or every three years). In addition, every six years thereafter, public companies must ask shareholders again about the frequency of the submission of the “say on pay” proposal to a shareholder vote. This provision will undoubtedly make compensation committees and boards of directors more aware of the sentiments of shareholders regarding executive compensation matters. Whether directors will bow to “say on pay” voting results remains to be seen.

In addition, beginning six months after enactment, public companies are also required to include a separate proposal in (1) their annual proxy statement; or (2) in their special meeting proxy statements that include a proposal related to an acquisition, merger, consolidation or proposed sale of all or substantially all assets of the company. This separate proposal will seek a nonbinding shareholder vote regarding compensation payments triggered by such transactions, which payments are generally referred to as “golden parachute” payments.[15] The disclosure must include the aggregate total of all such compensation and the conditions upon which it may be paid to, or on behalf of, an executive officer. Just like with the “say on pay” proposal described above, the results of this vote do not override board action or affect the board’s fiduciary duties under state law.

Enhanced Compensation Committee Independence Standards—The Act, through mandated changes to be adopted to the rules of national securities exchanges, requires that the compensation committee of an exchange listed company consist entirely of independent directors. Such rules must require that, in determining the independence of its compensation committee members, the board of directors of each public company consider the source of compensation received by each compensation committee member, including consulting, advisory or other compensation fees, as well as whether the compensation committee member is an affiliate.[16] The Act does not modify the current standards for listing on a national securities exchange which requires that directors of the compensation committee be independent. The Act also provides that the independent compensation committee may hire its own consultant, legal counsel or compensation advisor, after taking into consideration the following independence factors identified by the SEC, including:

• the provision of other services to the public company by the person that employs the advisor;
• the amount of fees received from the public company by the person that employs the advisor and the percentage such fees represent of the person’s net total revenue;
• the policies and procedures of the person that employs the advisor, which are designed to prevent conflicts of interest; 
• any business or personal relationships between the advisor and any member of the compensation committee; and 
• any stock of the public company owned by advisor.

The Act also requires that the proxy statement for any annual meeting of shareholders occurring one year after enactment includes disclosure regarding whether a compensation consultant was retained, and, if the consultant’s work raised a conflict of interest issue, the nature of the conflict issue and how the conflict is being addressed.

These provisions will undoubtedly place more emphasis on director independence and highlight conflicts occurring with respect to the retention of consultants. The Act also requires that the SEC perform a study on the use of independent compensation consultants and the effects of such use. The study must be completed in two years after the enactment of the Act, and may result in the recommendation of additional regulatory changes.

Pay vs. Performance—The SEC must promulgate rules requiring each public company to disclose in its annual meeting proxy statement or information statement a clear description of compensation required to be disclosed under the SEC proxy rules,[17] including information that shows the relationship between executive compensation actually paid and the company’s financial performance. This requirement will clearly provide fuel for shareholder activists that frequently attack companies on the grounds that executive compensation is not closely tied to performance.

Additional Compensation Disclosure—The SEC is required to promulgate rules requiring public companies to disclose in any filing made with the SEC that requires the disclosure of executive compensation the following information: 

• the median of the total annual compensation of all employees, except the CEO of the public company;
• the total annual compensation of the public company’s CEO; and
• the ratio of the median of the annual total compensation of all employees of the public company to the annual total compensation of the public company’s CEO.

This provision will undoubtedly create difficulty for many companies in calculating this information.

Enhanced Provisions Related to the Clawback of Compensation—The Act requires the SEC to adopt rules mandating the national securities exchanges to prohibit the listing of securities of any public company that does not develop and implement a policy providing for:

• disclosure of the company’s policy on incentive-based compensation that is based on financial information required to be reported under the securities laws; and 
• the recovery of such incentive compensation from a current or former executive in the event a restatement is required due to material noncompliance with the financial reporting requirements.[18]

In the event of a restatement of a public company’s financial statements due to material noncompliance with any financial reporting requirements under the federal securities laws, the public company will be required to recover from the current or former executive who received the incentive based compensation (which includes options) during the three year period preceding the date on which the company is required to prepare the restatement. The amount recovered must be based on the excess paid to the executive based on the erroneous financial data. This provision significantly increases the clawback provision currently contained in Section 304 of the Sarbanes-Oxley Act which provides for a one-year clawback of compensation in the event of the restatement of financial statements due to material noncompliance with the financial reporting requirements under the securities laws where the executive was engaged in misconduct which resulted in the erroneous financial statements. The enhanced clawback provisions contained in the Act require the return of compensation regardless of the reason for the restatement or the officer’s responsibility for the restatement. In addition, while the provision in the Sarbanes-Oxley Act only applied to the CEO and CFO where the new legislation applies the clawback to a broader group of executives.

Hedging Disclosures—The Act also requires that the SEC adopt rules mandating public companies to disclose in proxy or information statements for annual shareholders meetings whether any employee or director or the designee of such person 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 individual by the public company as compensation or held, directly or indirectly, by such person.[19]

Enhanced Compensation Reporting—Within nine months of its enactment, the Act requires federal regulators to jointly adopt regulations or guidelines regarding reporting of the structure of all incentive-based compensation arrangements offered by a covered financial institution.[20] This disclosure must be sufficient to enable the regulator to determine whether the structure:

• provides executives, directors, employees or principal shareholders with excessive incentive compensation, fees or benefits; or 
• could lead to a material financial loss to the covered financial institution.

Within the same timeframe, federal regulators must jointly adopt regulations or guidelines that prohibit any type of incentive-based payment arrangement that the regulators determine encourages inappropriate risks by covered financial institutions.

Elimination of Discretionary Voting by Brokers—Broker-dealers are now prohibited from voting securities held in street name, unless instructed by the beneficial holder how to vote, in connection with:

• the election of directors;
• executive compensation proposals; or
• any other significant proposal as determined by to-be-adopted SEC rules.

This provision was partially implemented as to NYSE-member firms through the amendment of NYSE Rule 452 last year. This change will likely require public companies to extend the time between the proxy mailing and meeting date and/or retain the services of a proxy solicitor to assist in obtaining the vote from street name holders.

Proxy Access—The Act authorizes the SEC to adopt rules in its discretion to permit shareholders of a public company to utilize proxy materials supplied by the company to include nominees for director submitted by the shareholders.[21] Congress left it to the SEC to determine the eligibility requirements shareholders must meet to utilize the company’s proxy statement to nominate directors. This issue of shareholder access has been hotly debated for years and the SEC requested authority from Congress to engage in a rule-making in this area given the fact that the authority to regulate the annual meeting process of corporations has traditionally rested with state legislatures. This requirement of the new law is no surprise as the SEC, on several occasions, has previously proposed rules addressing this issue.

Disclosure Related to the CEO/Chairman Structure—The Act requires the SEC to issue rules that require public companies to disclose in annual proxy materials sent to shareholders the reasons why the company chose:

• to have the same person serve as Chairman of the Board of Directors and CEO; or
• different individuals to serve as Chairman of the Board of Directors and CEO.[22]

The SEC had previously promulgated disclosure requirements related to this issue and many companies have already separated these two positions as this has long been considered a best practice in corporate governance.

Section 404 Relief for Small Issuers—One of the positive elements of the Act for public companies was the relief provided for smaller reporting companies from Section 404(b)23 of the Sarbanes-Oxley Act which requires the company’s independent public accountants to attest to management’s assessment of the effectiveness of the company’s internal controls. Under the new Act, companies that are not large accelerated filers or accelerated filers will be exempt from the requirement to provide such auditor attestation report. The SEC is also required to conduct a study on reducing the burden on companies with market capitalization between $75 million and $250 million of complying with Section 404(b) of the Sarbanes-Oxley Act.

Conclusion

Given the broad reach of this regulatory reform package and the fact that it will take years for the regulators to fully implement the requirements of the new legislation, it is difficult to determine at this point in time the full effect this legislation will have on the economy and its participants, particularly public companies. With respect to many of the corporate governance changes, their implementation through SEC rulemaking will ultimately determine the significance of their impact on public companies. More importantly, whether this lofty group of reforms will achieve the desired goals of eliminating financial instability and preventing another economic crises, without the unwanted effect of over-regulation of critical sectors of the economy, remains to be seen. Let’s keep our fingers crossed on this one!

Notes
[1] Provisions of the Act requiring rule-makings by regulatory agencies must take effect not less than 60 days after the publication of the final rule.
[2] Broc Romanek, TheCorporateCounsel.net Blog, July 13, 2010.
[3] Romanek at p. 1.
[4] See generally, Dodd-Frank Wall Street Reform and Consumer Protection Act, House Senate Conference Report on H.R. 4173 dated June 29, 2010 and subsequently approved by the U.S. House of Representatives on June 30, 2010.
[5] Nonbank financial companies include U.S. companies, other than bank holding companies, that are predominately engaged in financial activities. A company is “predominately engaged in financial activities” if 85% or more of its annual gross revenues from, or its consolidated assets related to, activities that are “financial in nature” as defined in the Bank Holding Company Act. See generally section 102(a)(6) of the Act.
[6] Proprietary trading means engaging as a principal for the trading account of the banking entity.
[7] See generally section 619 of the Act.
[8] See generally 12 U.S.C. § 343.
[9] The term “broad-based” is not defined in the Act.
[10] See generally section 911 of the Act.
[11] The SEC has indicated informally that the amount of any indebtedness secured by the principal residence should be netted from the value of the residence (except where the amount of the debt exceeds the fair market value of the residence and the lender has recourse to the investor personally for such excess, in which case such excess liability is deducted from net worth).
[12] While the law suggests that SEC action is required, the SEC has informally taken the position that the new legislation is immediately effective without further action.
[13] See generally section 922 of the Act.
[14] See generally section 951 of the Act.
[15] This provision is not applicable if the golden parachute payment was previously the subject of
a prior “say on pay” vote.
[16] See generally section 952 of the Act.
[17] See generally section 953 of the Act.
[18] See generally section 954 of the Act.
[19] See generally section 955 of the Act.
[20] See generally section 956 of the Act.
[21] See generally section 971 of the Act.
[22] See generally section 972 of the Act.
[23] See generally section 989G of the Act.