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Restoring American Financial Stability Act of 2009: A More Meaningful Definition of Independent Director

By J. Robert Brown

Talk about an unexpected change in the compensation structure that is buried in the Financial Stability Act.

The Financial Stability Act submitted by Senator Dodd also contains provisions that would reform the compensation process at the board level.  The provision does so, reminiscent of SOX, through the use of listing standards.  Moreover, the provision contains a mandatory right to cure.  In other words, companies can violate the requirements but not be penalized until given the right to cure. 

The use of listing standards to implement the requirement also raises other serious issues of enforceability.  The black letter law is that there is no private right of action for violations of the listings standards.  That leaves the exchanges to enforce the requirements, something that has not been adequate in the past.  Having said that, this determination arose in the context of listing standards voluntarily adopted by the stock exchanges.  They did not arise in the context of listing standards mandated by Congress.  The source of regulation, therefore, may make a difference in determining whether a private right of action exists. 

The requirements continue the process begun under SOX of empowering a committee of the boards of directors.  The proposed provision requires the use of independent consultants and gives to the compensation committee the authority to select the consultant.  The committee gets to determine its own funding.  These requirements represent a mild example of preemption, taking away from the board of directors the authority to authorize and fund a committee of the board.   

More importantly, the legislation would put the SEC smack into the middle of the governance process by giving it the authority to define director independence.  The provision provides that all directors on the compensation committee must be independent.  The definition of independence goes well beyond the one in SOX and the one in the shareholder bill of rights.  

The proposed section grants to the Commission the authority to dictate aspects of the definition.  More importantly, the SEC shall require the exchanges to consider all "relevant factors," including "the source of compensation of a member of the board of directors of an issuer"; this aspect of the definition appears to allow the Commission to require exchanges to consider the impact of fees on director independence.  This would result in a serious change in the current analysis, which "excludes" consideration of fees (fees arguably must be considered under the definition of the NYSE but the requirement is not enforced).   

In the meantime, the bill and a summary are posted at the DU Corporate Governance web site.

 
SEC. 10C. COMPENSATION COMMITTEES.

• (a) INDEPENDENCE OF COMPENSATION COMMITTEES.—

(1) LISTING STANDARDS.—The Commission shall, by rule, direct the national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that does not comply with the requirements of this section.

(2) INDEPENDENCE OF COMPENSATION COMMITTEES.—The rules of the Commission under paragraph (1) shall require that each member of the compensation committee of the board of directors of an issuer be—
(A) a member of the board of directors of the issuer; and
(B) independent.

(3) INDEPENDENCE.—The rules of the Commission under paragraph (1) shall require that, in
determining the definition of the term ‘independence' for purposes of paragraph (2), the national securities exchanges and the national securities associations shall consider relevant factors, including—
(A) the source of compensation of a member of the board of directors of an issuer; and
(B) whether a member of the board of directors of an issuer is affiliated with the issuer,
 a subsidiary of the issuer, or an affiliate of a  subsidiary of the issuer.

(4) EXEMPTION AUTHORITY.—The rules of the Commission under paragraph (1) shall permit a
national securities exchange or a national securities association to exempt a particular relationship from the requirements of paragraph (2), with respect to
the members of a compensation committee, as the national securities exchange or national securities association determines is appropriate, taking into consideration the size of an issuer and any other relevant factors.

• (b) INDEPENDENCE STANDARDS FOR COMPENSATION CONSULTANTS AND OTHER COMPENSATION COMMITTEE ADVISERS.—

(1) IN GENERAL.—Any compensation consultant, legal counsel, or other adviser to the compensation committee of an issuer shall be independent.
(2) RULES.—The Commission shall issue rules defining the term ‘independent' for purposes of this
subsection.

• (c) COMPENSATION COMMITTEE AUTHORITY RELATING TO COMPENSATION CONSULTANTS.—

(1) AUTHORITY TO RETAIN COMPENSATION CONSULTANT.—
(A) IN GENERAL.—The compensation committee of an issuer, in its capacity as a committee of the board of directors, may, in its sole discretion, retain or obtain the advice of a compensation consultant.
(B) DIRECT RESPONSIBILITY OF COMPENSATION COMMITTEE.—The compensation committee of an issuer shall be directly responsible for the appointment, compensation, and oversight of the work of a compensation consultant.
(C) RULE OF CONSTRUCTION.—This paragraph may not be construed— (i) to require the compensation committee to implement or act consistently with the advice or recommendations of the compensation consultant; or (ii) to affect the ability or obligation of a compensation committee to exercise its own judgment in fulfillment of the duties of the compensation committee.

(2) DISCLOSURE.—In any proxy or consent solicitation material for an annual meeting of the
shareholders (or a special meeting in lieu of the annual meeting) occurring on or after the date that is 1 year after the date of enactment of this section, each issuer shall disclose in the proxy or consent material, in accordance with regulations of the Commission, whether—
(A) the compensation committee of the issuer retained or obtained the advice of a compensation consultant; and ‘‘(B) the work of the compensation committee has raised any conflict of interest and, if so, the nature of the conflict and how the conflict is being addressed.

(3) STUDY REQUIRED.—(A) IN GENERAL.—The Commission shall conduct a study and review of—
(i) the use of compensation consultants by issuers in accordance with this section; and
(ii) the effects of the use of compensation consultants on the performance
of issuers.
(B) REPORT TO CONGRESS.—Not earlier than 3 years or later than 5 years after the date of enactment of this section, the Commission shall submit a report to Congress on the results of the study and review under subparagraph (A).

• (d) AUTHORITY TO ENGAGE INDEPENDENT LEGAL OUNSEL AND OTHER ADVISERS.—

(1) IN GENERAL.—The compensation committee of an issuer, in its capacity as a committee
of the board of directors, may, in its sole discretion, retain and obtain the advice of independent legal counsel and other advisers.

(2) DIRECT RESPONSIBILITY OF COMPENSATION COMMITTEE.—The compensation committee of
an issuer shall be directly responsible for the appointment, compensation, and oversight of the work of independent legal counsel and other advisers.

(3) RULE OF CONSTRUCTION.—This subsection may not be construed—(A) to require a compensation committee to implement or act consistently with the advice or recommendations of independent legal counsel or other advisers under this subsection; or (B) to affect the ability or obligation of a compensation committee to exercise its own judgment in fulfillment of the duties of the compensation committee.

• (e) COMPENSATION OF COMPENSATION CONSULTANTS, INDEPENDENT LEGAL COUNSEL, AND OTHER ADVISORS.—Each issuer shall provide for appropriate funding, as determined by the compensation committee in its capacity as a committee of the board of directors, for payment of reasonable compensation—

(1) to a compensation consultant; and
(2) to independent legal counsel or any other adviser to the compensation committee.

• (f) COMMISSION RULES.—

(1) IN GENERAL.—Not later than 360 days after the date of enactment of this section, the Commission shall, by rule, direct the national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that is not in compliance with the requirements of this section.
(2) OPPORTUNITY TO CURE DEFECTS.—The rules of the Commission under paragraph (1) shall
provide for appropriate procedures for an issuer to have a reasonable opportunity to cure any defects that would be the basis for the prohibition under paragraph (1), before the imposition of such prohibition.

(3) EXEMPTION AUTHORITY.—
(A) IN GENERAL.—The rules of the Commission under paragraph (1) shall permit a national securities exchange or a national securities association to exempt a category of issuers from the requirements under this section, as the national securities exchange or the national securities association determines is appropriate.
(B) CONSIDERATIONS.—In determining appropriate exemptions under subparagraph
(A), the national securities exchange or the national securities association shall take into account the potential impact of the requirements of this section on smaller reporting issuers.

 SEC. 954. EXECUTIVE COMPENSATION DISCLOSURES.

• Section 14 of the Securities Exchange Act of 1934 (15 U.S.C. 78n), as amended by this title, is amended by adding at the end the following:
• (j) DISCLOSURE OF EXECUTIVE COMPENSATION.—
  The Commission shall, by rule, require each issuer to disclose in the annual proxy statement of the issuer a clear description of any compensation required to be disclosed by the issuer under section 229.402 of title 17, Code of Federal Regulations (or any successor thereto), including— (1) information that shows the relationship between executive compensation and the financial performance of the issuer; and
  (2) a graphic or pictorial comparison of the amount of executive compensation and the financial performance of the issuer or return to investors of the issuer during a 5-year period, or such other period, as determined by the Commission.

 

SEC. 955. CLAWBACK.

• Section 16 of the Securities Exchange Act of 1934 (15 U.S.C. 78p) is amended by adding at the end the following:

(h) CLAWBACK POLICY.—Each issuer shall develop and implement a policy providing that, in the event that the issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer with any financial reporting requirement under the securities
laws, the issuer will recover from any current or former executive officer of the issuer who received incentive-based compensation (including stock options awarded as compensation) during the 3-year period preceding the date on which the issuer is required to prepare an accounting restatement based on the erroneous data, in excess of what would have been paid to the executive officer under the accounting restatement.

SEC. 956. DISCLOSURE REGARDING EMPLOYEE HEDGING.

• Section 14 of the Securities Exchange Act of 1934 (15 U.S.C. 78n), as amended by this title, is amended by adding at the end the following:

(l) DISCLOSURE OF HEDGING BY EMPLOYEES.—
The Commission shall, by rule, require each issuer to disclose in the annual proxy statement of the issuer whether the employees of the issuer are permitted to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars, and exchange funds) that are designed to hedge or offset any decrease in the market value of equity securities granted to employees by the issuer as part of an employee compensation.

Full post as published by The Race to the Bottom on November 30, 2009 (boomark / email).