Executive compensation is discussed throughout President Obama’s Financial Regulatory Reform issued by the Department of Treasury on June 17, 2009 (the “Regulatory Reform Proposal” or the “Proposal”). The theme throughout is that executive compensation must refocus on the correct fundamentals: Long-term value rather than short-term profits; financial stability, and management of risks.
The theme begins on the first page of the Regulatory Reform Proposal with a finding that that “Compensation practices throughout the financial services industry rewarded short-term profits at the expense of long-term value.” The theme is then developed further by proposing that federal regulators of financial institutions should issue standards and guidelines to better align compensation practices with the correct fundamentals through “five principles”:
- Compensation plans should properly measure and reward performance;
- Compensation should be structured to account for the time horizon of risks;
- Compensation practices should be aligned with sound risk management;
- Golden parachutes and supplemental retirement packages should be reexamined to determine whether they align the interests of executives and shareholders; and
- Transparency and accountability should be promoted in the process of setting compensation.
These principles are then expanded to include more than U.S. financial firms: Loan brokers and lenders; investment banking firms securitizing investments; publicly-held companies; and international companies subject to governance by G-20 countries
The regulation of executive compensation included in the June 2009 Regulatory Reform Proposal is more tempered than the regulation imposed in February, 2009 on companies receiving TARP funds (see Corporate Governance Blog posted February 4, 2009 on “U.S. Department of Treasury Guidelines for President Obama’s Executive Pay Limits”). For example, the TARP limitations on the dollar amount of total annual compensation other than restricted stock are not included.
Instead, the Regulatory Reform Proposal includes the more traditional “say-on-pay” empowerment of shareholders. The Proposal says the Obama Administration will work with Congress to pass legislation that will require all public companies to offer an annual non-binding vote on compensation packages for senior executive officers. The Proposal states that such votes “provide a strong message to management and boards and serve to support a culture of performance, transparency, and accountability in executive compensation. Shareholders are often concerned about large corporate bonus plans in situations in which they, as the company's owners, have experienced losses. Currently, these decisions are often not directly reviewed by shareholders – leaving shareholders with limited rights to voice their concerns about compensation through an advisory vote.”
Additionally, the Proposal recognizes the underlying principle of Sarbanes-Oxley: That the first and best line of defense against mismanagement and fraud is oversight by independent directors with advice of independent advisors (see Corporate Governance Blog posted March 30, 2009 with commentary on “A wishful alternative to Geithner’s proposed regulation”). The Proposal would give the SEC the power to require that compensation committees are more independent; compensation committees would have the responsibility and the resources to hire their own independent compensation consultants and outside counsel; and the SEC will create standards for ensuring the independence of compensation consultants, providing shareholders with the confidence that the compensation committee is receiving objective, expert advice.
Although the Proposal does not expressly include the TARP clawback bonuses to executives engaging in deceptive practices, the Sarbanes-Oxley clawback applicable to bonuses of executives of publicly-held companies remains available.
Finally, the Proposal criticizes the commissioned-based compensation of security brokers, originators, sponsors, underwriters, and others being compensated by those subject to the regulatory reform being proposed. The Proposal call for changing such commission based compensation to provide appropriate incentives for participants to best serve the interests of their clients, the borrowers and investor, linked to the longer-term performance rather than only to the production, creation or inception of products.
See Corporate Governance Blog posted on February 26, 2009 on “Cure for the Meltdown Requires Changing Focus” for further information on principle-based compensation similar to that discussed by the Proposal.