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Stockholders of publicly traded corporations are now more willing than ever to hold corporate directors, especially those serving on compensation committees, accountable for what many perceive as excessive executive compensation. The recently finalized SEC listing standards on compensation committee independence will add fuel to the oversight fire, bolstered by past issues, such as the high-profile shareholder suit against the board of directors of the Walt Disney Co. and Michael Ovitz.
Robert M. Fields
While the Delaware courts ultimately ruled in favor of Ovitz and Disney’s board, they certainly gave no ringing endorsement of the board’s oversight practices. Corporate directors should not take much comfort in the outcome. Had it not been for certain procedural matters, the ultimate decision may very well have been against Ovitz and Disney’s board. Accordingly, many compensation committees took this decision as a wake-up call to revisit their policies for limiting potential legal exposure.
Compensation committees and other board members have the greatest chance of satisfying the requirements of their fiduciary duty of “due care” and, accordingly, enjoying the protection of the business judgment rule, if they adopt and utilize certain “best practices” in the process of carrying out their duties. These best practices have traditionally included:
- giving the members of the compensation committee adequate notice of the matters to be discussed at forthcoming meetings so that they have time to review all appropriate documentation and marshal their thoughts prior to the meetings;
- setting aside sufficient time at the meetings for the members of the committee to ask questions of their compensation experts and of each other and to engage in substantive deliberations of the matter at hand;
- giving the members of the committee sufficient time for final consideration and vote (preferably at a follow-up meeting); and keeping detailed and accurate minutes of the discussions engaged in at the meetings.
Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 essentially encourages an enhancement of these best practices by imposing new independence requirements on board compensation committees, legal counsel and compensation consultants. SEC regulations promulgated under Section 952 of Dodd-Frank require the various stock exchanges to issue listing standards regarding the independence of the members of board compensation committees and the right of the compensation committees to engage independent compensation consultants, legal counsel and other advisors. In fact, the listing standards must require that the compensation committees consider the independence of compensation consultants, legal counsel and other advisors before they can be engaged. Proposed listing standards must be issued within 90 days of the effective date of the final SEC regulations and final listing standards must be issued within one year.
These new regulations, and the listing standards to be issued in response to them, give compensation committees the ability to truly operate independently of corporate management. As substantial compensation committee and advisor independence would ultimately benefit corporate stockholders and the public at large, adhering to the intent of this new law is crucial to a corporation’s obtaining the public’s acceptance of, and trust in, its compensation programs.
Independent counsel and compensation consultants can best ensure compensation committee independence since the corporation’s general outside lawyers may not be completely unbiased as to compensation issues due to their relationship with the CEO and other senior officers. Independent counsel is especially necessary when the company enters into compensation/contract negotiations with the CEO or senior executives. In-house counsel may not want to negotiate against their future superiors and general corporate counsel may not have sufficient independence. Lastly, independent counsel can best work with the corporation’s compensation consultant in giving totally unbiased opinions and advice as to the propriety of various levels and types of compensation. By definition, independent counsel should have no underlying agenda to curry favor with corporate executives.
It is important to note that independent legal counsel can supplement, and not necessarily replace, a compensation committee’s ongoing relationship with general corporate counsel and compensation consultants. He or she will provide independent, substantive input on various key issues, yet work with compensation consultants, general outside counsel and in-house attorneys to effectively develop reasonable and sound executive compensation programs and policies. The additional “pair of eyes” provided by independent counsel will result in synergies in the development of new ideas and concepts.
As mentioned above, the final regulations require the stock exchanges to issue listing standards requiring a listed corporation’s compensation committee to take into account the independence of compensation consultants, legal counsel and other advisors before any of these service providers can be engaged by the committee. There are real dangers if this is not done on a formal basis. First, a corporation’s stock can be delisted by an exchange if the corporation cannot establish in its annual certification, press release or otherwise (in a form to be determined by the stock exchanges in their listing standards) that the independence factors were taken into account. Furthermore, in this day of an increased volume of litigation over executive compensation, it is to be expected that plaintiff’s counsel in shareholder derivative actions now will know to look for formal proof that the factors were considered. If such proof is not made available, the corporation runs the risk of being on the losing side of the legal action.
All in all, in light of the dangers described above, it will be incumbent upon compensation committees to satisfy the independence requirements relating to compensation consultants, legal counsel and other advisors in formal, written documents. Furthermore, since these documents may be made public by plaintiff’s counsel (or by direction of the exchanges) corporate best practices would suggest that compensation committees seriously consider engaging independent compensation consultants or independent legal counsel, even if such engagements are in conjunction with the utilization of other, non-independent, advisors.
Robert M. Fields is an attorney with over 30 years of experience in dealing with the tax, corporate and securities aspects of executive compensation and has represented a number of compensation committees in his career. He is a partner in the firm of Fox Rothschild LLP, located in its New York City office. Fields is a 1975 graduate of Duke University and a 1978 graduate of the Cornell Law School. He also earned a Master of Laws in Taxation degree from the Georgetown University Law Center. You can contact Fields by telephone at 212-905-2315, by email at rfields@foxrothschild.com or by U.S. mail at his offices located at 100 Park Ave., Suite 1500, New York, New York 10017.