Eyes On Wall Street : Executive Compensation Lawyers & Attorneys : Labaton Sucharow Law Firm : Class Action Litigation, Shareholder Rights

The SEC has finally issued much-anticipated proposed rules regarding executive compensation.

On March 30, 2011, the SEC unanimously proposed rules directing the national securities exchanges to adopt certain listing standards related to the compensation committee of a company’s board of directors as well as its compensation advisers pursuant to the requirements set forth in the section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The proposed rules require the exchanges to adopt listing standards that 1) require each member on a compensation committee be a member of the board of directors and be independent; and 2) provide that compensation committee has the authority to retain compensation advisers and is responsible for the appointment, compensation and work of any such adviser.

The proposed rules also require each company to disclose in its proxy material for an annual meeting of shareholders 1) whether its board’s compensation committee retained or obtained the advice of a compensation consultant, and 2) whether the work of the compensation consultant has raised any conflict of interest and, if so, the nature of the conflict and how the conflict is being addressed. 

Once an exchange’s new listing standards are in effect, a listed company will be required to meet these standards in order for its shares to continue to be traded on the exchange. Comments to the proposed amendments are due on or before April 29, 2011.

Contributed by Yoko Goto.

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With newly proposed rules regarding naked access and executive compensation, the SEC is making significant inroads in shoring up investors’ confidence in the markets and in the Commission itself. 

One of the Commission’s recent achievements is newly- proposed rules to prohibit broker-dealers from providing customers with “unfiltered” or “naked” access to an exchange or alternative trading system. The proposed rules, which were unanimously approved last week, would require brokers with market access, including those who sponsor customers’ access to an exchange, to put in place risk management controls and supervisory procedures. The proposed procedures would help prevent erroneous orders, ensure compliance with regulatory requirements, and enforce pre-set credit or capital thresholds.

Another notable recent achievement is the new executive compensation disclosure rules that were adopted last December and will take effect with this year’s proxies.

In the past, the executive compensation disclosure rules contained loopholes permitting public companies to hide information regarding equity grants, which is most important part of the package for many executives. Under the new rules, companies will have to disclose this information to investors in a summary table. 

Even under this improved regulatory scheme, however, companies may still be able to minimize the awards they disclose when grants are tied to undisclosed performance goals. The amounts disclosed will reflect only what the company asserts that executives are likely to be paid, with little meaningful way for auditors or investors to assess the reliability of these estimates.

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America is experiencing an extraordinary period of legislative and regulatory executive compensation reform. In fact, executive compensation reform is so much in vogue that many companies are even voluntarily introducing so-called Say on Pay resolutions. 

Since Treasury Secretary Geithner first proclaimed that companies in receipt of TARP assistance would have to subject executive compensation to Say on Pay resolutions in February 2009, thirteen publicly-traded companies that did not receive TARP monies—including Verizon, Motorola, and Blockbuster—have willingly adopted the Say on Pay way. 

In addition to these thirteen corporate compensation pioneers, eleven other leading publicly-traded companies that did not receive TARP funds—such as Microsoft and Apple—have either willingly scheduled Say on Pay votes for 2010 or have already voted but not yet released results. 

These voluntary say on pay resolutions revise compensation disclosure by, among other things, changing the Summary Compensation Table (“SCT”) reporting of stock and option awards and by broadening the scope of the Compensation Discussion and Analysis (“CD&A”) to include a new section that analyzes the link between a company’s overall compensation policies and the company’s risk and management of that risk. 

Say on Pay resolutions further require that compensation committees be independent, and that such committees disclose the use of consultants and advisors (who are also required to be independent). In addition, such provisions require disclosure of specific performance targets, and also seek to enhance proxy access for stockholder proposals and director nominations.   

Adoption of Say on Pay provisions will result in closer scrutiny of executive pay arrangements by boards and compensation committees. Better-informed and qualified boards and compensation committees, in turn, may help restore investors' faith in corporate governance after the crises of the last two years.

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On October 22 Wall Street received a double whammy with the release of plans by the Federal Reserve and the Treasury Department to aggressively regulate pay practices at banks. While both approaches capitalize on public wrath erupting over the announcement of record-setting year-end bonuses at top financial firms, they differ significantly in scope and effect. 

The Federal Reserve’s new compensation proposal, outlined in its October 22 press release, has the broadest sweep, covering thousands of banks, including U.S. subsidiaries of foreign institutions. While the proposed rules would not directly regulate pay, they would include demands that firms take into account losses incurred by employees, make pay tied to longer-term performance, and pay out over longer stretches of time. The only real teeth in this regulation, however, is the Fed’s right to veto compensation plans it does not like, and to require that management come up with better approaches. 

The Treasury plan is more limited in scope, but has a much more immediate impact. The plan, outlined in an October 22 press release titled The Special Master for TARP Executive Compensation Issues First Rulings, applies only to the beneficiaries of bailout funds under the TARP program. It attempts to better align pay with longer-term performance, but takes a more direct approach than the Fed. Treasury official Kenneth Feinberg, the Obama administration’s “pay czar,” slashed cash compensation, increased stock awards, and insisted that stock compensation be held for two to four years. Salaries paid to the highest-earning executives at seven companies getting exceptional federal aid will also be capped at $500K, while the group’s total pay level, annualized, will be 50% lower than last year.

Not surprisingly, the financial services industry is not happy with either approach. Although the sector benefited from last year’s massive infusion of taxpayer capital, banks are bridling at the suggestion that regulators—and the taxpayers they protect—should have any role in reforming the institutions that they helped save.

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The G-20 has finally weighed in on the issue of executive compensation. Why should investors care what global financial policy leaders think about performance-related bonuses? Because reforms aimed at ending the financial incentive for executives to bet the house on risky securities will only work if they are adopted uniformly.

There is little mystery about the role that fat-cat compensation packages played in last year’s financial crisis. Top management of investment banks enjoyed bonus packages that rewarded short term bets that could be disastrous for investors, while eliminating any downside risk to executives themselves. It should surprise no one that the result was a vast appetite for dangerous investments that would prove to have tragic long term consequences for investors and taxpayers.

In the Leaders' Statement from the September 24 – 25, 2009 Summit in Pittsburgh, G-20 leaders urged that reforming compensation packages is essential to any effort to increase financial stability. The leaders stated that reforms should ensure that compensation is aligned with long-term value creation for investors, rather than excessive risk-taking. They suggested that this could be accomplished by requiring that a large proportion of performance-related compensation be deferred and be tied to long-term performance. Moreover, they argued that such provisions should have teeth, in the form of claw-back provisions permitting companies to reclaim compensation from executives whose decisions land investors in hot water.

Of course, general statements of policy will be useless unless member countries enact rules enforcing restrictions on pay. A September 5, 2009 address to world leaders by Treasury Secretary Tim Geithner outlines the steps that are being taken in the U.S. to change executive pay structures. Geithner noted that the House has already passed proposals designed to tie compensation to long term performance, and stated that the Federal Reserve would be charged with enforcing the proposed new standards.

It remains to be seen whether any legislative effort to reform compensation can survive powerful lobbying efforts by management interests, but international cooperation on the issue is an encouraging sign.

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