Last week, the US Treasury delivered draft legislation to Congress concerning advisory “say on pay” votes and compensation committee independence. The next day, Congressman Barney Frank unveiled draft legislation, entitled the “Corporate and Financial Institution Compensation Fairness Act of 2009,” incorporating those proposals, which he intends to officially introduce before Congress’s August recess. In addition, the Frank bill includes a new proposal regarding “perverse incentives” in financial institution pay structures. We summarize the key provisions of each of these proposals below.
Advisory Say on Pay
The proposed say on pay legislation is substantially similar to the say on pay legislation that Mr. Frank sponsored in 2007 and was passed by the House in that year. The key provisions of the renewed say on pay legislation would:
- Require a non-binding annual shareholder vote on compensation for all public companies (not just TARP recipients as is currently the case). The vote to approve the compensation of the company’s executives as disclosed in its proxy statement would encompass the compensation committee report, the compensation discussion and analysis, the compensation tables, and any related materials.
- Require specific disclosure of, and a separate non-binding shareholder vote on, certain executive officer “golden parachute” arrangements in the case of certain mergers and acquisitions transactions. Disclosure would have to be made, in a “clear and simple tabular form,” with respect to any agreements or understandings the company has with any “principal executive officer” (under the Frank bill) or “executive officer” (under the Treasury proposal) concerning any type of compensation based on the transaction, along with the aggregate total of all such compensation that may be paid or become payable to the relevant executive officer. In the non-binding proposal, shareholders would be asked to approve the agreements or understandings and the compensation as disclosed.
- Impose these requirements with respect to proxies for annual meetings or transactions occurring on or after December 15, 2009. In addition, the SEC would be directed to issue any necessary rules and regulations within one year of enactment.
Compensation Committee Independence
The key provisions of the Compensation Committee Independence legislation, which are comparable to the provisions of the Sarbanes-Oxley Act’s standards relating to audit committees, would:
- Require compensation committee members of all public companies to meet new standards for independence, effective not later than 270 days after enactment. In order to be considered independent, the member would not be able to accept any consulting, advisory, or other compensatory fees from the company, other than directors’ fees, and could not be an “affiliated person” of the company or any subsidiary.
- Require any compensation consultants, legal counsel, or other advisors hired by the committee to be independent of management. Compensation committees would have the authority, but would not have any obligation, to hire their own advisors. Effective as of the year after enactment, companies would, however, have to disclose in their proxies whether their compensation committee had hired an independent compensation consultant, or explain why they had not. This disclosure requirement would not apply to legal counsel or other advisors.
- Provide funding for compensation committees to engage independent advisors. Companies would be required to provide the funding the compensation committee might deem appropriate to retain independent compensation consultants, legal counsel, and other advisors.
“Perverse Incentives” in Financial Institution Compensation
Finally, the key provisions of the enhanced compensation structure reporting requirements in the Frank bill would:
- Require “covered financial institutions” to disclose to Federal regulators the structure of their incentive-based compensation arrangements for their officers and employees. The disclosures would have to be sufficient to permit the applicable regulator to determine whether the program (i) properly measures and rewards performance; (ii) is structured to account for the time horizon of risks; (iii) is aligned with sound risk management; and (iv) meets other criteria established by the applicable Federal regulators to reduce unreasonable incentives for officers and employees to take undue risks that could have serious adverse effects.
- Prohibit any arrangements that encourage inappropriate risks. Federal regulators would be directed to issue regulations prohibiting any compensation structure or incentive-based payment arrangement (or any feature thereof) that encourages inappropriate risks by financial institutions or their officers or employees that could (i) have serious adverse effects on economic conditions or financial stability generally, or (ii) threaten the safety and soundness of the covered financial institution.
- Define “covered financial institution” broadly. The bill casts a wide net in defining covered financial institutions. In addition to FDIC insured institutions and their holding companies, the legislation would also cover broker-dealers, credit unions, investment advisors, and any other financial institution that the relevant Federal regulators deem appropriate.
It remains to be seen how these proposals will progress and what form they may ultimately take