Getting Ready for the 2010 Proxy Season

Are you ready for the 2010 proxy season? Companies are faced with new rules for expanded disclosure of executive compensation and director experience in the proxy statement. They have more issues that will come under more scrutiny from more people, be they activist investors, proxy advisory services, pension and union funds, or the media. Here’s what you need to consider to be prepared for the proxy season ahead.

New proxy disclosure rules go into effect on Feb. 28. You will need to discuss the board’s leadership structure—essentially, whether the company has a combined chairman and CEO or separates the roles—and explain why that works best for the company. If you have the combined functions and designate a lead independent director to chair the independent directors’ meetings, you will need to explain why you have chosen that option.

You will be required to discuss board diversity and how the nominating committee considers diversity issues in director nominations, and whether the board has a diversity policy—and if so, how is it implemented and assessed.

Companies will also need to disclose each director’s “specific experience, qualifications, attributes, or skills that led the board to conclude that the person should serve as a director for the company at the time of the filing.” This disclosure will be made annually. The final rule does not require disclosure of a director’s qualifications to serve on a specific board committee.

Companies will also need to disclose any directorships held by each director and director nominee during the past five years at any public company or a registered management investment company. You must also disclose if the executive officers, directors, and director nominees have been involved in legal actions during the past 10 years. Be sure to have your directors review their information to ensure it’s accurate and complete.

The new proxy rules change the way stock and option awards are disclosed in the Summary Compensation Table and the Director Compensation Table, by requiring the aggregate grant-date fair value of these awards computed in accordance with Accounting Standards Codification Topic 718, which sets fair value by grant date rather than the dollar amount for financial statement purposes.

The rules require additional disclosure about the fees paid to compensation consultants and their affiliates under certain circumstances defined in the rule. The SEC believes that transparency in this area will help investors determine if there are conflicts of interest inherent in the selection process.

Companies will be required to disclose whether their compensation policies and practices for employees are likely to have a material adverse effect on the company, and you must discuss the company’s compensation policies or practices as they relate to risk management and risk-taking incentives that are tied to the management of that risk.

Finally, disclosure of voting results from the shareholder meeting will be filed on Form 8-K within four business days of the meeting. No longer will results be reported on Forms 10-Q or 10-K.

The elimination of broker voting of non-instructed shares in director elections should cause companies to assess the potential effect of the change in their annual elections. Companies that have a high percentage of institutional ownership will be less affected than those that have a large number of retail shareholders. Those in the latter category will need to assess the possibility of having insufficient votes to constitute a quorum for the annual shareholder meeting and whether they may need to hire a proxy solicitation firm to get the needed votes.

In the past, most of the broker votes were cast in support of management. Companies can no longer count on that. The SEC’s Office of Investor Education and Assistance is urging individual investors to vote their proxies if they do not instruct their brokers how to vote. Be aware that this rule change will deal the activist investors a stronger hand in gaining majority votes on proxy resolutions they champion.

Executive compensation continues to gain momentum with each proxy season. Many companies will face say-on-pay proposals this year if they have not already adopted the concept voluntarily. Given that we are likely to see Congressional legislation in 2010 requiring that companies give shareholders an opportunity to cast an advisory vote on executive compensation, a growing number of corporations have voluntarily adopted say-on-pay in their proxies.

Preparing for the 2010 proxy season is an immediate concern for calendar-year companies. If your year-end is later, you still have time to do some relationship building with those voting the proxies.

A recent survey conducted by the Shareholder Forum sent to a range of professional investors found that most want to know what directors have done to align executive compensation with corporate strategy, rather than whether it conforms to the guidelines of proxy advisory services such as RiskMetrics. This is why a clear explanation of the board’s criteria for determining the top executives’ compensation is so important to the Compensation Discussion & Analysis.

Shareholder activists will press forward on majority voting, which many companies have voluntarily adopted, as well as say-on-pay and related executive compensation issues. Some will advocate separating the roles of chairman and CEO. Socially responsible investors will examine corporate practices in their realm of interest and may propose specific proxy resolutions that go beyond ordinary business and get them on the proxy.

Companies should assess what motivates the shareholder activists, and consider meeting with them to see whether areas of agreement or compromise exist. Ignoring them can be a mistake, particularly if they misunderstand what the company is doing.

Form a proxy committee consisting of the general counsel, corporate secretary, and the investor relations officer. This committee should meet with the top institutional investors as soon as possible to discuss the company’s position on specific proxy issues, especially contentious ones. Ideally, building a relationship with those who vote the proxies should be done before the heat of the proxy season. But it’s not too late to engage them now.

In most major investment funds, the proxy-voting group is separate from the fund managers who the IRO, CFO, and CEO meet with to explain the company’s strategy and how they are creating shareholder value. Therefore, it behooves the IRO to build a relationship with the proxy-voting group in the “off season.” In some mid-size and smaller funds, however, the portfolio manager may also vote the proxies. In that case, the IRO should have already established a relationship with the portfolio manager. The few companies I know that engage those who vote the proxies have had a positive experience, if nothing more than because they demonstrate that they care about what their investors think.

Focus first on funds that have their own proxy voting guidelines. The second tier would be those funds that subscribe to the advice of proxy advisory firms, since they are not staffed to review each company’s proxy. This group can pose a significant challenge since they tend to follow the voting recommendations of the advisory firms (or, worse yet, outsource the voting to their firm).

Some of the proxy advisory firms and pubic pension funds publicly disclose what issues they are focusing on in the proxy season and what positions they take. Other institutional investors will often disclose their voting guidelines. Knowing what you are dealing with before meeting with them can be invaluable.

If, for example, you find that there is a majority position among investment funds on specific governance issues, it may be an opportunity to consider voluntarily adopting emerging best governance practices and avoid a majority or near majority vote against the company.

Preparing for the 2010 proxy season is an immediate concern for calendar-year companies. If your year-end is later, you still have time to do some relationship building with those voting the proxies. Hopefully, this checklist will provide a roadmap to ensure you are in compliance with the new rules and to position your company as authentically responsive to shareowners.