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Encouraging directors to break down barriers, seek “honest disclosure” and focus on improving communication, Mary L. Schapiro, chair of the Securities and Exchange Commission, spoke before a packed room at the recent National Association of Corporate Directors Annual Corporate Governance Conference. Schapiro addressed key SEC agenda items relating to Dodd-Frank, urging directors to engage with shareholders and the Commission as it seeks to understand the balance between disclosure and the burden of regulation.
It is a pleasure to be here with you today, at a moment when so much about what we do is being fundamentally transformed. I have some idea of the challenges you face—I am in the trenches on many of the same issues you’re grappling with, trying to ensure that the SEC meets Congressional mandates and investor needs effectively, but also with minimal regulatory burden.
I know that your responsibilities as corporate directors are growing at a dramatic rate. And honestly, the expectations for how corporate governance can fortify our economic system— through vigilance, risk management and transparency—have never been higher.
Shareholders expect you not only to know your business—how to control risk, market, compete, profit and grow in an increasingly global marketplace but, in many cases, to know about and effectively oversee the impact that your businesses may have on the financial system.
At the same time, much of the regulatory framework within which your businesses operate is also changing. Our responsibility is to ensure that our own rules support and do not interfere with governance characteristics that market participants, or in some cases, Congress, have identified as significant.
When consensus has been reached that certain features are relevant to effective governance, then our rules regulating disclosure and the proxy process should ensure that this information is provided. How that information is interpreted and acted upon is up to board members and to the shareholders who elect them.
When it comes to the securities markets, we are the guardians of honest disclosure. Companies and boards must tell their shareholders, current and prospective, the truth—and the whole truth—about those matters, which are important to investment decision-making, including governance.
Making Engagement a Priority
Speaking both as a regulator and as a former board member, I believe that it is vital that shareholders and board members move beyond the minimum required communications and become truly engaged in the shared pursuit of high-quality governance. Engagement is a two-way street. As the report of the NACD’s Blue Ribbon Commission on Board-Shareholder Communications points out, boards can benefit from access to the ideas and the concerns investors may have. Good communications can build credibility with shareholders and potentially enhance corporate strategies.
As we move to consider Dodd-Frank requirements and public comments on our proxy plumbing release, we would like to engage with you, as well. Your voices will help ensure that the right balance is struck between the goal of increased disclosure and the burdens new rules might present. We look forward to hearing from you.
Increased Disclosures
Last year, the SEC took one step that I believe has great potential to improve communications concerning a very important point—that is, why a company’s board members are the right people for their positions. We adopted new regulations that, for the first time, required describing what in the director’s background and skill set led the board to select that individual. In the past, all that was presented in proxies about director candidates was a brief biography that did little to communicate important information regarding the unique or significant value candidates might add to a particular company’s board.
In just their first year, these rules resulted, with some exceptions, in proxy statements that were more informative. In one example, the proxy tells investors that “Ms. Gray”—of course, not her real name—“has spent her career in consumer businesses and brings key financial and operations experience to the company…. [she] possesses broad expertise in strategic planning, branding and marketing, business development, retail goods and sales and distribution on a global scale. Ms. Gray’s positions as chief financial officer and her service on the audit committees of other companies… also impart significant expertise to the board…”
Contrast that with another example—again, changed slightly from the original filing. In this one, each candidate presents only the same bare-bones biography that has been required for decades. Then, the proxy merely adds a sentence at the end of the section which essentially says: “Our directors each have integrity, sound business judgment and honesty, which are important characteristics of a good board member.”
Now, we have been told that some board members were advised that they should keep the new information to a minimum. I disagree. I think filings like the second one increase the distance between boards and shareholders, to the detriment of both.
In that same rulemaking project, we also adopted new disclosure requirements addressing other key concerns of shareholders. We required companies to disclose why they selected a particular board leadership structure.
Why do they have a combined CEO and chair? Or why have they separated them? We didn’t take sides on this issue; that’s not our role. But questioning a board’s structure is the shareholders’ role, so we wanted boards to give shareholders clear and accurate answers. We required detailed information about compensation consultant fees when the consultant does other work for the company, to address concerns that compensation committees might be receiving advice about management compensation from consultants who are beholden to management for other business.
The Dodd-Frank Act amplifies this requirement, with consideration of other potential conflicts. So these disclosures will be changing further as we implement new provisions through our upcoming rulemakings.
Addressing Risk
In light of heightened concerns about how boards address risk, we also added a new requirement, that boards explain how they oversee risk at the company. Some companies simply recited lines like “risk is overseen by the board as a whole.” I believe investors feel better informed and reassured by more detailed disclosures. Further, we added a requirement that companies assess whether their compensation programs expose them to material risks. This requirement applies to compensation throughout the company —not just executives—and to companies in all industries, not just financial firms. For financial-services firms, Dodd-Frank takes this issue further and requires financial regulators to adopt regulations or guidelines that prohibit incentive-based compensation arrangements that encourage inappropriate risk-taking.
Compensation
Among the highest-profile governance rulemakings now before us are the ones required by Dodd-Frank that concern executive compensation. Dodd-Frank will require advisory say-on-pay votes at all companies at least once every three years, starting at meetings on or after January 21, 2011. Shareholders will also vote on how often they would like to have the say-on-pay vote, and will have a similar “say” on golden parachutes. Dodd-Frank also required exchanges to amend their rules-governing circumstances in which brokers vote proxies without instruction from beneficial holders, to prohibit voting on compensation matters, such as the say-on-pay votes. The New York Stock Exchange has already implemented this new mandate, putting it in place for the first round of mandatory say-on-pay votes starting in January.
The next proposal that you will see in this area will be the rules requiring that stock exchanges mandate new standards of independence for compensation committees at listed companies. That rulemaking will also address the conflict-of-interest factors that boards must consider when retaining compensation consultants. One of the more widely publicized provisions of Dodd-Frank will require companies to calculate and disclose the median total compensation of all employees, and the ratio of CEO compensation to that figure, in accordance with rules that govern disclosure of executive compensation. Next summer we will also issue proposals to require disclosure of the relationship between senior executives’ compensation and the company’s financial performance, as well as whether employees or directors are permitted to hedge against a decrease in value of company securities granted as part of their compensation.
In addition, we will be proposing new standards under which listed companies will be required to develop “clawback” policies for reclaiming incentive-based compensation from current and former executive officers after a material financial restatement. As you know, SEC rules already require a robust discussion of compensation decisions in the annual proxy statement’s Compensation Discussion and Analysis. But, with these new requirements it will be particularly important for boards to communicate the reasons for their compensation decisions effectively to shareholders.
Voting Infrastructure
The SEC is in the early stages of another important proxy initiative. Formally, it’s called our “voting infrastructure” project. Informally, we refer to it as “proxy plumbing”—an apt term for the complicated and sometimes creaky system through which information and votes flow during proxy season. Every year, over 600 billion shares are voted at more than 13,000 shareholder meetings. Yet it has been 30 years since the Commission has conducted a thorough review of this infrastructure.
Voting, of course, is the main point of the proxy process. And so, we’re looking at several different areas. We’re interested in knowing the extent to which there is under- and overvoting of shares. We’d like to find a reasonable way to confirm votes, and to know if this is an issue for companies, as well. We’re also extremely interested in whether and how we can facilitate greater participation by retail investors in proxy voting.
In addition, we’re asking whether data-tagging proxy-related data, such as information relating to executive compensation, would enhance shareholders’ ability to make informed decisions when they do vote. And, finally, we believe that it is important that the right to vote be tightly tied to the outcome of that vote. We’ve asked if the phenomenon of “empty voting” is widespread and damaging enough to warrant a regulatory response.
Our second concern is ongoing communication between the board and shareholders. Most importantly, does the OBO/NOBO system balance the competing interests of investor privacy and effective communications appropriately? Or does it erect unnecessary barriers between you and the shareholders you represent? And we’d like to know your opinion on proxy distribution. Are fees reasonable? Do you see a way to bring greater competition—and possibly lower price and better service—to the industry?
Proxy Advisory Firms
Finally, we’ll be examining the role of proxy advisory firms. Both companies and investors have raised concerns that proxy advisory firms may be subject to undisclosed conflicts of interest. In addition, they may fail to conduct adequate research, or may base recommendations on erroneous or incomplete facts. We intend to fully explore these issues.
The SEC cannot and is not interested in determining the communications strategies of individual companies. But we are interested in breaking down barriers that may prevent effective engagement, and affect investor confidence and, ultimately, financial performance. The decisions we will be making in the months ahead are decisions that demand your attention and input.