The Advisors' Blog

– Doug Friske, Paula Todd and Steve Seelig, Towers Watson

In addition to ushering in the say-on-pay era in the United States and making other significant changes in the legislative framework for executive compensation and corporate governance, the Dodd-Frank Act opens a new and more constructive chapter in the debate about the independence of advisors to compensation committees. Specifically, Dodd-Frank expands the recent focus on multiservice consulting firms to a broader range of executive compensation advisors (including lawyers retained by compensation committees) and a wider array of potential conflicts of interest.

The legislation requires compensation committees to closely examine all potential and actual conflicts of interest that could arise with any advisor that they hire. Such potential conflicts go well beyond the assessment as to whether the consulting firm that employs the compensation committee’s executive compensation consultant also provides other services to the corporation. These so-called “other service” conflicts are the only type of potential conflict that may require companies to disclose their consulting fees under the SEC proxy disclosure requirement that took effect earlier this year.

Under Dodd-Frank, no category of advisors to board compensation committees is automatically exempt from potential conflicts, nor are there any “safe harbors” for specific categories of advisors (e.g., boutique executive compensation consulting firms that, by definition, provide no other services to their clients). In fact, the legislation stipulates that future SEC requirements must be “competitively neutral among categories of consultants, legal counsel, or other advisors and preserve the ability of compensation committees to retain the services of members of any such category…”

With this broader focus, compensation committees should no longer be tempted to take a “one size fits all” approach to thinking about the potential conflicts of their executive compensation advisors. In selecting consultants, compensation committees should look for advisors that are most appropriate for their own particular needs. Such needs include the reputation and resources of the consulting firm (including data, global reach and other factors), as well as the qualifications, experience, personal chemistry and availability of individuals who will work directly with the committee. In short, committees should evaluate all conflicts that could potentially get in the way of the consultant providing fully objective advice – and then determine whether and how any such conflicts can be mitigated.

This memo has answers to some of the most common questions companies have been asking about the legislation’s implications for consultant independence and the selection of executive compensation advisors.