Is Your Board’s Compensation Committee Up to Standard?
Boards of directors are responsible for corporate governance of their companies, although the companies’ executives oversee most day-to-day activities. To ensure that these executives perform properly, the boards oversee them, and establish compensation and incentives intended to encourage and reward appropriate activities. State corporation laws and federal and state securities laws, have traditionally left boards to decide how to meet these responsibilities.
Over the past decade, however, lawmakers and regulators have responded to highly publicized scandals by introducing more stringent standards for executive compensation programs. These new standards are mandatory for publicly-traded companies, and increasingly are expected by non-public company shareholders as well. Most recently, the Securities and Exchange Commission (SEC) issued rules late last month establishing new requirements for public company compensation committee structure and authority.
Implementing New Responsibilities Imposed by Dodd-Frank
SEC’s new rules implement directives imposed by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) section 952.[i] These rules are nearly a year late, as SEC has been struggling to complete nearly one hundred new rulemaking requirements and dozens of additional discretionary ones.
Requiring Independent Compensation Committees with Access to Outside Advice
New SEC Rule 10C-1 requires national securities exchanges and associations to enhance their listing standards – the requirements companies must meet in order to list shares for trading. These new standards must provide the following:
- Every member of the company’s Compensation Committee must be an “independent” director (generally, not paid as an employee of, consultant or affiliate to, the company or any of its corporate affiliates).
- The Compensation Committee must be provided authority and funding to retain outside compensation consultants and legal advisors, independent of management and the rest of the board of directors.
- Any outside consultants and advisors must also be “independent” of the company.
Each exchange and association must file proposed standards by September 25, 2012, to be finalized and then approved by SEC, no later than June 27, 2013. SEC’s rules allow for limited exemptions for smaller reporting companies, foreign companies (if they disclose their non-compliance), limited partnerships and open-ended management investment companies, and companies in bankruptcy.
Requiring Issuers to Disclose Their Status in Proxy Materials
SEC disclosure protocols are fundamental to these changes. SEC is revising its proxy rules, to require issuers of SEC-registered securities to include the following information in each proxy:
- Whether the Compensation Committee has retained or obtained advice from a compensation consultant; and,
- Whether the consultant’s work raises any conflicts of interest, and if so, how the conflict is being addressed
Issuers must include this information in any solicitation for every annual or other meeting on or after January 1, 2013, that includes the election of directors.
Fitting These New Responsibilities into Context
These new requirements are just the latest in a series of statutory and regulatory initiatives over the past decade that are intended to improve the design and implementation of executive compensation programs, reporting of these programs to shareholders and potential investors, and opportunities for shareholders to have their “Say on Pay.”
The following Implementation Checklist incorporates these provisions. As you work through the checklist, remember that these provisions are only required if your company is publicly traded, but that even if your company is privately held you should consider whether to incorporate some or all of them into your governance and your reports to shareholders.
SEC Compensation Checklist
- Does my company’s Board of Directors include a standing Compensation Committee?
- How many Committee members are “independent” of the company and its management?
- Does the Board provide the Committee with authority to hire outside compensation and legal advisors, with the funding authority to hire those advisors without clearance by the full Board and management?
- Does the Committee actually hire outside advisors (every year, periodically, occasionally/as-needed), and does it ensure that any such advisors are also “independent”?
- Has the Board established formal policies governing the design of executive compensation programs? Were these policies developed by:
- Another Board committee?
- Management or other inside personnel?
- Outside advisors?
- Do these policies include incentive-based compensation (including any stock options), based on the company’s financial results and other factors?
- Do these policies include claw-back provisions, triggered by findings of wrongdoing by the executive (and/or of the company), financial adjustments and/or other factors?
- Do these policies include post-severance provisions (e.g., “golden parachutes”)?
- How often are these policies subject to formal review and possible revision?
- Does the company report its executive compensation program (to shareholders and the public in compliance with SEC disclosure requirements, if applicable)?
- Does the company provide shareholders a formal “Say on Pay” vote on these matters? Is the vote:
- Binding (i.e., as shareholder ratification of the terms)?
- Advisory (the minimum standard for most SEC-registered companies effective in 2011, and “smaller reporting companies” in 2013)?