On Friday, the House passed H.R. 3269 “Corporate and Financial Institution Compensation Fairness Act of 2009,” which is Rep. Barney Frank’s latest version of a say-on-pay bill, mostly along partisan politics lines by a vote of 237-185. This follows the marked-up version of the bill that the House Financial Services Committee passed on Tuesday. There are notable differences between what the House passed and the language that the Obama Administration (through the Treasury Department) recommended in June.
Two years ago, the House passed a different say-on-pay bill by a vote of 269 to 134 (afterwards, then-Sen. Obama floated the same bill in the Senate but it never went anywhere). The Senate is not expected to consider similar legislation until sometime after the August recess – and it’s expected that there will be a tougher battle in the Senate over the bill’s terms.
Here is a final version of the bill. And here is the House Financial Service Committee’s marked-up version of the bill (with the only reported major change being the clawback reversal noted below) – and here is that Committee’s report.
Below are key provisions of the bill’s three major components, with commentary gleaned from a variety of sources:
1. Say-on-Pay: Section 2
– Likely Not Applicable to ’10 Proxy Season – Effective date for this Section is six months after SEC adopts rules implementing this Section; and the SEC is directed to adopt rules within six months of enactment of the bill into law. The upshot is that say-on-pay is not likely to be applied to the ’10 proxy season, but perhaps could be effective later in 2010. Treasury’s recommendation was to adopt something before the ’10 proxy season.
– FPIs Excepted – No Triennial Alternative – Requires annual non-binding vote on disclosure of executive compensation arrangements and “golden parachutes”; mark-up clarified that neither applies to foreign private issuers. Note that the idea of a triennial vote (ie. Carpenters Union’s alternative) was considered during the mark-up but defeated.
– SEC Might Exempt Small Businesses – Gives authority to the SEC to exempt certain types of companies from say-on-pay; SEC might use this to exempt smaller businesses. Treasury recommendation didn’t address this topic.
– Investment Managers Report How They Vote – Requires certain types of investment managers to report annually how they voted on say-on-pay at the companies for which they own at least $100 million of their equity at some point during the preceding 12 months. Treasury recommendation didn’t include this likely-to-be controversial item.
– No Tabular Format for Golden Parachute Disclosures – For say-on-pay on golden parachutes, tabular format eliminated during mark-up; and mark-up clarified that golden parachutes previously approved by shareholders must be disclosed, but need not be voted upon again. I can’t figure out why tabular disclosures were dropped – in my opinion, dropping it was not a good idea.
– Clawbacks Still Possible Even If Shareholders Approve Compensation – The mark-up had produced an amendment that would have prohibited clawbacks of compensation arrangements that had approved by shareholders – the only amendment made to the marked-up bill on Friday was striking this new provision. So under the bill approved by the House, clawbacks are still possible even if the compensation disclosure has been approved by shareholders.
2. Compensation Committee Independence: Section 3
– Even Longer Effective Date – The exchanges (as directed by the SEC) wouldn’t be required to adopt listing standards to implement this Section until 9 months after the bill was enacted.
– Compensation Committees Must Be Independent – The thrust of this section is to have independent compensation committees (although mark-up eliminated requirement that comp committee members not be “affiliated persons”). Some of the more controversial aspects of the Treasury’s recommendations were reined in by the House bill, as noted below.
– SEC Might Exempt Small Businesses – Gives authority to the SEC to exempt certain types of companies from this Section; SEC might use this to exempt smaller businesses. Treasury recommendation didn’t address this topic.
– No Need to Disclose Why Didn’t Hire Compensation Consultant – During the mark-up, the requirement to provide potentially embarrassing disclosure regarding why a compensation committee didn’t hire a consultant was struck. However, companies would be required to provide funding for compensation consultants (as well as lawyers) if the compensation committee wanted to hire one.
– Compensation Consultants Must Be Independent – The SEC must adopt independence standards for compensation consultants. The mark-up clarifies that these standards must be competitively neutral.
– Lawyers Need Not Be Independent – During the mark-up, the requirement for the compensation committee’s counsel to meet independence standards was eliminated.
– SEC’s Study – Within two years, the SEC must provide a study regarding the impact of its new independence standards to Congress.
3. Regulation of Compensation at Large Financial Institutions: Section 4
This Section would regulate pay at large financial institutions – those with more than $1 billion in assets – particularly their incentive-based pay packages. It would require federal regulators to prohibit “certain compensation” structures at large financial institutions if they could have a “serious adverse effect on financial stability.” It would also require federal regulators to adopt rules requiring these institutions to disclose their incentive-based pay plans for executives and employees – and then the regulators would determine if the pay packages are “aligned with sound risk management.”
This is quite a controversial Section (eg. the issue of whether the government can abrogate a private contract) – and it was not part of the Treasury’s recommendations. I would be surprised to see this Section survive the Senate, even with all the public anger over Wall Street bonuses. This recent Bloomberg article notes skepticism over this Section expressed by the Obama Administration and some Senators.
There is a hodge-podge of other provisions in the bill. One example is a GAO study of the correlation between compensation structure and excessive risk-taking. Note that the foregoing recap is subject to the caveat that we haven’t yet seen the final bill as adopted. Let me know if I got something wrong…
Recently, Ted Allen blogged about an important new case – Louisiana Municipal Police Employees v. Ritter – in which an Alabama state judge temporarily froze executive payments at
Regions Financial Corporation at the request of a pension
fund. In our “Comp Litigation” Portal, we have posted the complaint – and here’s the temporary restraining order.
And for those following compensation litigation, don’t forget the important Delaware Court of Chancery’s opinion on a motion to dismiss from In Re Citigroup Inc. Shareholder DerivativeLitigation.
According to this Bloomberg article, Germany recently passed a law that will limit the amount of compensation companies are permitted to pay their executives, surpassing the restrictions both in the U.S. and UK.
Highlights of the new law include:
– It will be easier for supervisory boards to cut board pay in the case of “extraordinary” developments.
– Supervisory boards will be subject to increased liability if they approve excessive salaries for management.
– If management board members are held liable for damage to the company, they can be held personally liable for at least 10% of the damage, but no more than 1.5 times their fixed annual salary.
– Board members will only be able to cash in their share options after four years (the current requirement is after two years).
– Disclosure of executive compensation will become mandatory unless 75% of shareholders vote against it.
This new law is in addition to the restrictions passed last October, which limit compensation for top executives at banks taking government bailout funds to €500,000 ($670,000) and bans bonuses, stock options and severance.
Germany has a two-tier board system: a management board and a supervisory board. The supervisory board of large corporations is composed of 20 members, ten of which are elected by the shareholders, the other ten being employee representatives. The supervisory board oversees and appoints the members of the management board and must approve major business decisions.
We recently released our report, which analyzes compensation disclosures filed by 50 companies in early 2009 and compares them to our findings during the prior two years (see this blog from last Spring) to glean what they foretell about ’10 CD&As. The new report also includes data on pay disclosures by participants in the TARP. Among our findings:
– 65% of companies with performance-based cash incentive plans disclosed their specific targets, with 19% of the remaining companies giving a reason for withholding those details.
– 30% of the companies studied disclosed examining their incentive plans to ensure they do not encourage unnecessary and excessive risk-taking
– 40% of companies disclosed clawback provisions, up significantly from 28% in 2008 and 22% in 2007 (due largely to a requirement that companies receiving funds from the Troubled Asset Relief Program have clawbacks in place.)
– 74% of companies reported ownership guidelines for executive equity awards, up from 70% in 2008 and 62% in 2007.
As an independent compensation consultant to boards, I should be delighted with the Treasury’s proposed legislation requiring consultants hired by compensation committees to be independent. I am not delighted. I am very concerned for two reasons:
1. Independence does not guarantee high quality consulting or high quality compensation. Anyone can hang out a shingle and call themselves a compensation consultant. Our profession is in sore need of generally accepted principles and standards, as well as a rigorous certification process for consultants.
2. This could cause a shake-up in the consulting industry, forcing firms to be either board consultants or management consultants. I am not sure this is healthy. It will also add unnecessary expense for companies, especially smaller companies. While larger firms can afford two consultants – one for management and one for the board – this is just not cost effective or operationally efficient for smaller companies.
Before the financial crunch, the battle between regulators and bankers used to be one-sided; both agreed that bankers generally knew best, Breakingviews says. Bonuses, for example, were an internal matter. Post-crisis, however, regulators want more say. Britain’s Financial Services Authority, run by Hector Sants, has just laid down a line — a tough one by its usual standards — on multiyear guaranteed bonuses.
In a letter sent to more than 40 chief executives, it suggested such practices “may be inconsistent” with its pending approach to remuneration, which is based on keeping rewards aligned with risk. Institutions based in Britain are not happy, especially with the idea that employment contracts signed as early as March, when the F.S.A. published its first consultation paper, could come under scrutiny, Breakingviews says. To them, the approach seems unfair and gets in the way of the high pay revival sweeping the industry. Even government-controlled banks, including Royal Bank of Scotland in Britain and Citigroup in the United States, are paying up for talent, the publication notes.
In theory, regulators could stop not only multiyear guarantees but also any reversion to old pay practices. The F.S.A. and its peers in the United States and elsewhere could decide that gargantuan pay packages were simply off the table, Breakingviews says. A few months ago, such a blanket decree, with a few exceptions, seemed plausible, it says. In practice, the mood has changed, the publication suggests. The exceptions could now become the rule, Breakingviews argues. When governments are turning a blind eye to the hiring practices of the banks under their control, regulators will have trouble being much tougher, it says.
The F.S.A. may still try, Breakingviews says. Banks would be foolish to ignore its letter completely or protest too loudly, the publication says. The regulator has the authority to levy fines or even to increase capital requirements for institutions it judges are careless about pay, it notes. But wily bankers can probably protect their rewards without direct confrontations, according to the publication. Better to cut back on egregious contract terms, while marshaling persuasive arguments about how bankers and traders are getting extra pay for keeping a particularly close eye on the risks they are taking, Breakingviews says.
Yesterday, the SEC announced an action to clawback bonuses and stock profits from a former CEO under Section 304 of Sarbanes-Oxley. The SEC asked the U.S. District Court for the District of Arizona to order the former CEO of CSK Auto Corporation, Maynard Jenkins, to reimburse the company for more than $4 million that he received in bonuses and stock sale profits while the company was committing accounting fraud. This is the third Enforcement action that the SEC has brought regarding CSK’s alleged accounting shenanigans, which resulted in two restatements – one of them charges four of the company’s executives with wrongdoing (but not the former CEO).
Although this is not the first Section 304 action from the SEC, it’s the first one where the “clawee” isn’t alleged to have violated the securities laws. The SEC has brought very few 304 actions since the provision was enacted seven years ago, mainly because of the uncertainty over what constitutes the “misconduct” required by the provision. Here is how Section 304 opens:
If an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws, the chief executive officer and chief financial officer of the issuer shall reimburse the issuer…
As noted in the “D&O Diary” Blog, “there is no requirement in Section 304 that the CEO or the CFO from whom the reimbursement is sought have any involvement in the events that necessitated the restatement. Indeed, the statute doesn’t require any showing of wrongdoing or fault at all.” And remember there is no private right-of-action under 304 – only the SEC can enforce it.
Okay, so what type of “misconduct” did the SEC find here? For openers, the SEC’s press release refers to the CEO as the “captain of the ship.” Did the SEC decide that the captain is responsible for the ship and that alone is enough to find “misconduct”? I don’t think so.
Based on a cursory reading of the SEC’s complaint, I believe the SEC found that the captain engaged in some “misconduct” – but that misconduct didn’t amount to a violation of the securities laws. I get to this conclusion by noting that a number of the allegations (i.e. #43-47) in the SEC’s complaint explain the “conduct” and “misconduct” by the company that led to this action and then #48 states: “By engaging in the conduct described above, Jenkins violated, and unless ordered to comply will continue to violate, Section 304(a) of the Act, 15 U.S.C. § 7243(a).”
There’s not a lot of meat in the SEC’s allegations to explain what role the former CEO actually had in the accounting fraud, leaving the SEC open to criticism (such as this Ideoblog commentary). But maybe that’s the SEC’s point – that merely being captain of the ship while rampant fraud occurs on your watch is “misconduct” enough. We’ll be posting memos analyzing this case in our “Clawback Policies” Practice Area.
At a minimum, the SEC’s action seems like a wake-up call to CEOs and CFOs of companies that have had restatements due to some accounting misconduct: you are not safe – the SEC may come after you. And hopefully, this action will spur companies to attempt to enforce their own clawback policies (Equilar reports more than 64% of the Fortune 100 now have them; compared to just 17% in ’06). I’m not aware of any company that ever has (although it’s possible it has happened behind closed doors). I imagine companies sometimes deal with situations where it’s not clear if their own clawback policy – or Section 304 – applies. Or if it does apply, whether it’s prudent to seek recapture from the executive (weighing cost/time of litigation; indemnification issues, etc.).
We just posted a complimentary copy of the Summer 2009
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Recently, RiskMetrics canvassed some compensation consultants about whether they would find a peer benchmarking tool useful when helping to set executive pay levels. While I appreciate RiskMetrics’ desire to expand its services, their concept ignores the fact that peer group selection is not automatic and requires experienced analysis and judgment of numerous factors, many unique to each company.
To name just a few, in addition to industry and size (parameters that vary based on the nature of the business), we consider organization structure, financial structure, corporate strategy, performance metrics, ownership, global presence, make vs. buy/outsource, distribution channels, internal growth vs. acquisitions, etc.
I am also concerned that RiskMetrics’ fourth party automatic selection will require companies, as well as their consultants, to defend their selections vs. those of RiskMetrics in the event of a challenge, especially litigation.
Perhaps most important, I’ve also reviewed RiskMetrics’ historic selection of peers in numerous voting advisory reports and find them questionable – if not invalid – with respect to both pay and performance comparisons. Let me know what you think.
Things are moving fast on the legislative front as Rep. Barney Frank circulated a “discussion draft” on Friday of his “Corporate and Financial Institution Compensation Fairness Act of 2009” to the House Financial Services Committee. This bill is the House version of what Treasury sent to the Hill last Thursday.
– Dave Lynn, Partner, Morrison & Foerster and Editor, CompensationStandards.com
– Mark Borges, Principal, Compensia
– Jeremy Goldstein, Partner, Wachtell Lipton Rosen & Katz
– Jannice Koors, Managing Director, Pearl Meyer & Ptrs
– Mark Trevino, Partner, Sullivan & Cromwell LLP
Our “6th Annual Executive Compensation Conference“: Now that we have a sense of what Congress will likely pass before next year kicks off, you need to register now to attend our popular conferences and get prepared for a wild proxy season:
“4th Annual Proxy Disclosure Conference” & “6th Annual Executive Compensation Conference.” You automatically get to attend both Conferences for the price of one; they will be held November 9-10th in San Francisco and via Live Nationwide Video Webcast. Here is the agenda for the Proxy Disclosure Conference. Register now.