The U.S. Securities and Exchange Commission voted unanimously today to propose new rules on the independence of compensation committees and to authorize pay panels to hire consultants.

The independence of the compensation-setting process has long been a concern for activist investors, who have filed shareholder proposals in the past calling for more disclosure on potential conflicts of interest and to keep multiple outside CEOs from sitting on pay panels.

The proposed rules closely track the provisions of Section 952 of the Dodd-Frank Act. Under the draft rules, the New York Stock Exchange and the Nasdaq Stock Market would be directed to revisit their listing standards and to determine whether to raise the independence requirements for compensation committee members. In developing a new independence definition, the exchanges are to consider a director’s sources of compensation, such as consulting or advisory fees from the company, as well as whether a director is affiliated with the company or a subsidiary.
 
Unlike the Sarbanes-Oxley Act, which mandated stricter independence standards for audit committees, the Dodd-Frank Act and the SEC rules do not require the exchanges to adopt standards that would bar directors with such relationships from serving on pay panels. Given the flexibility in the law, it’s possible that the NYSE and the Nasdaq may propose different independence standards. 

The proposed rules also include new disclosure requirements. Companies would have to disclose in their annual proxy statements whether they retained a compensation consultant, if the consultant’s work raised any potential conflicts of interest, and how any such conflict was addressed.

In addition, the draft SEC rules direct the exchanges to authorize compensation committees to hire pay advisers, and provide that the committee would be directly responsible for the oversight and payment of any adviser. 

The draft rules also direct the exchanges to adopt new listing standards on the independence of compensation advisers and legal counsel. Under this proposal, compensation committees are to consider five factors before hiring an adviser, including: whether the adviser’s firm provides other services to the company; the amount of fees received from the company and the percentage of the consulting firm’s total revenue; the policies and procedures adopted by the consulting firm to mitigate conflicts of interest; whether the adviser has any personal or business relationships with committee members; and if the adviser owns any company stock.

It remains unclear whether the new listing standards would be in place before the 2012 proxy season. The deadline for comments is April 29, and the SEC is required by the Dodd-Frank Act to adopt final rules by this July. The exchanges would have to propose listing standards within 90 days after the final SEC rules are published in the Federal Register. Once the listing standards are proposed, they would be subject to final approval by the SEC.
 

On March 30, the U.S. Securities and Exchange Commission plans to consider draft rules to address compensation committee independence and pay consultants. The SEC will consider these rules at an 10 a.m. open meeting at its headquarters in Washington, according to the meeting agenda.

Under Section 952 of the Dodd-Frank Act, the SEC is to direct the New York Stock Exchange and the Nasdaq Stock Market  to adopt new listing standards with respect to compensation committees and pay advisers. Most large U.S. companies already have fully independent compensation committees, but the new rules likely will require pay panel members to meet a higher standard of independence, like the standard that now applies to audit committees. Section 952 also directs the SEC to adopt new disclosure rules concerning the use of compensation consultants and conflicts of interest. 

At its annual meeting today, technology giant Hewlett-Packard failed to obtain majority support during an advisory vote on its pay practices, according to Bloomberg News. H-P is the fourth U.S. company this year to suffer this rebuke from investors.

The opposition from H-P shareholders may reflect concern over the lucrative pay package for new CEO Leo Apotheker and the independence of the five new board members that he helped recruit. In the past, the company provided generous severance payouts after the board ousted former chief executives Mark Hurd and Carly Fiorina. 

Apotheker's pay arrangements include substantial up-front signing awards of cash and stock, and severance provisions that would result in sizeable payouts--including automatic vesting of all his time-based equity--upon his termination without cause. Many aspects of the company's incentive programs are subject to board discretion as well, and depend on the board exercising its authority objectively--e.g., the granting of discretionary bonuses and approval of higher-than-median pay benchmarking. The company has paid substantial discretionary awards and does not disclose goals for the key metrics that drive payouts under its annual and long-term plans, even retrospectively. Without complete disclosure, shareholders cannot ascertain the rigor of the goals relative to payouts.  

Earlier this week, Shuffle Master, a Las Vegas-based maker of casino equipment, reported that investors gave just 44.1 percent support to management during a non-binding vote on compensation at the March 17 annual meeting. Shuffle Master has a market cap of about $550 million and is in the Russell 3000 index.   

The vote at Shuffle Master appears to reflect investor concerns over the severance terms in an employment agreement that was reached with interim CEO David Lopez in February. That agreement included a “modified single-trigger” provision that would have allowed Lopez to receive severance if he decided to leave the company within 90 days of a change in control. Many investors object to single-trigger provisions that don’t require executives to actually lose their jobs to receive a payout. 

On March 16, Shuffle Master announced that it had hired a new CEO, Michael Gavin Isaacs, who will start work on April 1. Lopez is to remain as the chief operating officer and continue serving on the board, the company said.   

In addition to H-P and Shuffle Master, two other firms--Jacobs Engineering Group and Beazer Homes USA--have failed to win majority approval for their pay practices this year. With a few exceptions, most issuers have earned wide support during this season’s “say on pay” votes. The support for management has averaged 90.7 percent, according to ISS Voting Analytics data as of March 22, which includes results from 117 companies.
 

The debate over the best frequency for “say on pay” votes has reached a tipping point, as a majority of S&P 500 and Russell 3000 firms have urged their investors to support annual advisory votes on executive compensation. 

As required by the Dodd-Frank Act, this year’s corporate proxy statements include a “say when” vote that asks investors to express their views on whether advisory votes on compensation should be held every year, every two years, or every three years. The percentage of annual recommendations has been growing in recent weeks, as more boards have heeded the large majority votes by investors for annual votes at early season meetings.   

So far, 105 (60.7 percent) of the 173 large-cap firms that have filed proxy materials had endorsed annual votes, as compared to the 56 companies (32.4 percent) where management endorsed triennial votes, according to ISS data as of March 22. Seven firms have favored a biennial frequency, while five issuers made no recommendation. 

At the 417 Russell 3000 firms that have released proxy materials, the number of companies with annual recommendations, which once trailed triennial by a 2-to-1 margin, has climbed to 210 (50.4 percent). Meanwhile, 182 firms (43.6 percent) have backed triennial, followed by 13 issuers with biennial recommendations, and 12 companies that stayed neutral. 

Triennial recommendations remain more prevalent at smaller companies that are outside the Russell 3000. Among those firms, 66.1 percent have endorsed votes every three years, as compared with the 24.3 percent that have supported annual votes, according to ISS data, which includes 115 small-cap companies. 

These varying corporate views on pay vote frequency is another example of the growing divergence in U.S. governance practices based on market capitalization. As a general matter, larger firms have been far more responsive to the demands by shareholder activists for majority voting and other reforms.   

As required by the Dodd-Frank Act, this year’s corporate proxy statements include a “say when” vote that asks investors to express their views on whether advisory votes on compensation should be held every year, every two years, or every three years. 

Earlier this year, issuers were recommending triennial votes by a 2-to-1 margin, but most investors voted instead for annual frequency. So far, there has been 63.6 percent average approval for annual, more than twice the 29.5 percent support for triennial, according to ISS data as of March 15. There has been 4.9 percent support for biennial votes, while 2 percent have abstained. 

At six large-cap firms, investors overwhelmingly defied management’s triennial recommendation and gave more than 60 percent support for annual votes. Examples include: Monsanto (62.2 percent support for annual); Rockwell Automation (64.1 percent); Varian Medical (75.8 percent); AmerisourceBergen (75.4 percent); Air Products (60.3 percent); and Jacobs Engineering Group (67 percent).  

So far, only one of the 14 large-cap firms with a triennial recommendation has won majority approval from investors for its chosen frequency, according to ISS data. That firm was Tyson Foods, which has a dual-class equity structure. Within Russell 3000 index, just 15 of 36 issuers have earned majority support for triennial votes; most of those firms have unequal voting rights or significant holdings by insiders.    

In response to these early votes, a significant number of companies have recommended annual votes in the past few recent weeks. At the 106 S&P 500 firms that have filed proxy statements, 61 companies (57.5 percent) have endorsed annual votes, followed by 38 issuers that preferred triennial, three that called for biennial votes, and four firms that made no recommendation, according to ISS data. Coca-Cola Enterprises, AES, Newmont Mining, Lennar, Eli Lilly, Weyerhaeuser, Whirlpool, and Humana Inc. are among the large-cap firms that have endorsed annual votes in recent proxy filings. 

There also has been a similar evolution in management views at smaller companies. Among the 241 Russell 3000 firms that have released proxy materials, a plurality (46.1 percent) have endorsed annual votes, as compared to the 45.2 percent with triennial recommendations, according to ISS data as of March 15. A week ago, the percentage of Russell 3000 companies with annual recommendations was 38.2 percent.   

However, triennial recommendations remain more common at small firms outside the Russell 3000. At the 94 firms with “say when” on the ballot, a large majority (68.1 percent) have called for triennial votes, according to ISS data.
 

In a significant no-action ruling, the Securities and Exchange Commission has turned down Citigroup’s request to omit a new proposal from New York City’s pension funds that seeks a report on the bank’s mortgage lending practices.

The first-year proposal calls for an independent review by Citigroup’s audit committee of the bank’s internal controls related to loan modifications, foreclosures, and securitizations. The proposal, which also is supported by state pension funds from New York, Connecticut, Illinois, Oregon, and North Carolina, was inspired by news reports of “robo-signers” and other irregularities in loan foreclosures. The proponents have said they hold $1.1 billion in Citigroup stock.    

In a March 2 ruling, the staff of the Corporation Finance Division rejected the company’s arguments that the proposal related to “ordinary business operations,” had been substantially implemented, and that the resolution’s request for an “independent review” was impermissibly vague.

In turning down Citigroup’s ordinary business argument, which is often used to exclude new proposals, the SEC staff cited “the public debate concerning widespread deficiencies in the foreclosure and loan modification processes for real estate loans and the increasing recognition that these issues raise significant policy considerations.”  

Similar shareholder proposals have been filed at Wells Fargo, Bank of America, and JPMorgan Chase. Michael Garland of the NYC funds said the proposal would appear on the ballot at Wells Fargo, but still faces no-action requests from Bank of America and JPMorgan Chase.
 

Shareholder activist John Chevedden and his retail investor network continue to survive corporate no-action challenges on eligibility grounds.

In separate rulings, the staff of the SEC’s Corporation Finance Division has rejected requests by Prudential Financial, Union Pacific, and Devon Energy to omit governance proposals filed by Chevedden. All three companies argued that Chevedden’s proof-of-ownership letters from Ram Trust Services (RTS) did not comply with SEC Rule 14a-8(b), which requires investors to demonstrate that they continuously owned at least $2,000 in company stock for a year before filing a shareholder proposal. Under that rule, investors may show eligibility by submitting a letter from the "record holder" of their securities, such as broker or a bank. In the past, the SEC staff has ruled that a supporting letter from an "introducing broker" would suffice, but it has not authorized the use of letters from investment advisers.

Each of the RTS letters stated that Chevedden holds shares through RTS, and RTS in turns holds those shares in an account with Northern Trust Co. In their no-action requests, the three companies asserted that the RTS letter was deficient because it was not from an "introducing broker," and they argued that RTS was an investment adviser and thus cannot verify proof of ownership. In response, Chevedden said that RTS, a Maine-chartered non-depositary trust company, was a record holder because it had custody of his shares, and he pointed out that RTS does not provide him with investment management services. 

Unlike in some recent decisions, the SEC staff did not elaborate on why it was rejecting the no-action requests from Devon Energy, Union Pacific, or Prudential, other than to indicate that it was unable to concur with the companies’ arguments.

Yahoo! has made a similar objection in its no-action request to exclude a written consent proposal filed by Chevedden. Apache and KBR have not filed no-action requests this year, but they have informed the SEC that they plan to exclude 2011 Chevedden proposals that also are supported by RTS letters. As of March 2, the SEC staff had yet to publicly weigh in the proposals at Apache and KBR. Apache sued Chevedden last year and won a federal court ruling that a similar RTS letter was not sufficient under Rule 14a-8(b), but Chevedden has argued that this ruling was based on erroneous information provided by Apache. KBR has filed a similar lawsuit this year in the same federal court in Texas where Apache won its decision.

Meanwhile, the SEC also continues to turn aside eligibility challenges to proposals submitted by other members of Chevedden’s investor network. The commission staff recently rejected challenges by Allstate, McGraw Hill, and JPMorgan Chase to written consent proposals filed by Kenneth Steiner, as well as Amgen’s attempt to exclude a written consent resolution from William Steiner. In all four cases, the companies questioned the authenticity of proof-of-ownership letters from DJF Discount Brokers. The companies alleged that it appears that Chevedden added the stock ownership details to the letter, but Mark Filiberto, the DJF official whose signature was on the letters, since has confirmed that he signed them and supervised their production.

At the same time, companies have had success raising eligibility challenges this season against other proponents. So far, the SEC staff has allowed companies to omit 14 governance proposals based on proof-of-ownership objections, according to ISS data. In most cases, the proponents failed to provide any further evidence or correspondence after receiving a deficiency notice from a company.