Today I will follow-up on my previous blogs on the SEC's Final Rule on Compensation Committee Independence and Outside Advisers, issued last week, with four other observations on implications of the rule for legal counsel. The SEC rule provides that aCompensation Committee is required to conduct the independence assessment using the six independence factors set forth in Rule 10C-1(b)(4) with respect to any compensation consultant, legal counsel or other adviser that provides advice to the compensation committee, other than in-house legal counsel.Since most Compensation Committees still seek and receive advice from executive compensation partners at the company's regular corporate law firm, this could lead to some big changes in the next 12 months. 

Nearly every Compensation Committee in corporate America regularly or from time to time seeks the advice of outside legal counsel specializing in executive compensation (generally including tax, securities law, state law fiduciary duties, the design, drafting, and implementation of plans and agreements, and familiarity with the marketplace). 

First, the SEC's rule expressly states that the Compensation Committee need not consider the six independence factors before consulting with or obtaining advice from in-house counsel. 

Second, the first two of the six independence factors that aCompensation Committee must consider are:

  1. The provision of other services to the company by the firm that "employs" [most advisers will be partners] the legal counsel; and
  2. The amount of fees received from the company by the law firm that "employs" the legal counsel, as a percentage of the total revenue of the firm. 

If the law firm with which the legal counsel is a partner who handles a few other minor legal matters for the company, there would seem to be no issue of independence under these two factors. However, if the partner's law firm handles legal matters for the company that are significant and recurring, the Committee must know the amount of fees received from the company by the law firm, as a percentage of the total revenue of the firm. As a practical matter, one company/client will not constitute a significant percentage of the total revenue of most large law firms. However, given the realities of practice in a law firm, I suggest that the more relevant question for the Committee to ask legal counsel is whether the amount of fees received from the company by his/her law firm is large enough to create a risk that the legal counsel might be reluctant to take a position that could anger the company's management (e.g., those with the authority to hire and fire the law firm).

Regarding this factor, it might be useful for legal counsel to point out that a lawyer has an ethical obligation to withdraw from (or not accept) representation of a client if he/she believes that some other interest, influence, or relationship could prevent the lawyer from zealously representing the client's interests (or, colloquially, if the lawyer might "pull his punches" in representing the client). I believe that most law firms would state that the firm would not penalize a partner for giving sound legal advice to the compensation committee of a client (e.g., "your CEO appears to be overpaid"), even when that advice angered the client's management. I also believe in Santa Claus. Executive compensation counsel's fear that the law firm would reduce his/her compensation or otherwise punish him/her for putting a larger client relationship at risk is exactly the kind of potential conflict relationship that the SEC's rules are trying to uncover and prevent. This is precisely the potential conflict relationship that led to the strict independence and disclosure rules applicable to compensation consultants.

Third, Compensation Committees and companies probably need to think about this assessment immediately, certainly before year end 2012, in time for any changes in the relationship or disclosure in the 2013 proxy statement. The company's general counsel or chief legal officer should take a couple steps in advance to prepare for the possibility of independent legal counsel. First, the general counsel should review the company's policies and guidelines for engagement of and billing by outside counsel. The general counsel may need to make changes to accommodate this new reality. Second, the general counsel should meet with the compensation committee chair to coordinate on this matter. For example, the committee chair should know whether the company has adopted guidelines for engagement and billing by outside counsel so that the committee can follow the necessary procedures if it decides to engage independent counsel. 

Fourth, the rule provides that a Compensation Committees may select any compensation adviser it prefers, including ones that are not independent, after considering the six independence factors outlined in the final rule. The rule does not require independent legal counsel. However, when the SEC mandates a process such as this new independence assessment, it usually wants companies to reach – or at least consider – a certain result. Thus, the issue is one of following best practices.