Corporate Governance

The Permanent Solution: HR 3269 and the Regulation of Executive Compensation (Part 1)

By J. Robert Brown

With so much activity and so little time, we have not had a chance to comment on the ‘‘Corporate and Financial Institution Compensation Fairness Act of 2009," legislation introduced by Barney Frank in the House and recently passed by the House Committee on Financial Affairs but what was apparently a relatively straight party vote of 40 to 28.  It passed the House by a vote of 237 to 185.  

The legislation fundamentally addresses the excessive compensation issue.  It goes about it in two ways.  First, the Exchange Act would be amended to make "say on pay" (including a separate vote on golden parachutes) mandatory.  Appearing in Section 14, the provision would only apply to reporting companies (those with 500 shareholders of record and $10 million in assets).  

In addition, however, the Bill proposes changes at the board level, mimicking the provisions in SOX with respect to audit committees (See Section 301 of SOX).  First, the provision extends only to exchange traded companies.  The language (as does Section 301) allows the SEC to impose the requirements on national securities associations (i.e. FINRA), something that could arguably extend the requirements to the Bulletin Board.  But the requirement only extends to listed companies and, at least in the current vernacular, Bulletin Board companies are not listed. 

Second, the Bill requires that compensation committees be made up of independent directors and that the directors meet the somewhat stricter definition of independent contained in SOX for audit committee directors.  Compensation consultants must meet a definition of independence (presumably eliminating consultants who have other material financial relationships with the company) and the committee must have the authority to designate the consultant, stripping the authority from the full board (which ordinarily includes the CEO).  

The standard does not require the use of a compensation consultant.  The provision, however, evokes comply or explain.  If the committee does not use an independent compensation committee, it must explain the omission.  This will likely encourage companies to use them, forcing compensation committees to have "independent" advice when making compensation decisions. 

Third, as with audit committees, the compensation committee is to determine its own funding.  This is a small but fundamental change in the state law system of corporate governance.  All state statutes provide that managerial authority rests with the board.  Yet SOX and HR 3269 stripped the funding decision from the entire board and vested it in a rump group of directors. 

Finally, financial regulators (including the SEC) would be required to write rules prohibiting compensation structures that encourage inappropriate risk or that could have "serious adverse effects on economic conditions or financial stability."  The rules would, however, only apply to financial institutions. 

We will assess these proposals in a second post.

Full post as published by The Race to the Bottom on August 12, 2009 (boomark / email).