April is truly the cruelest month for public companies—to paraphrase T. S. Eliot. Filing taxes on the fifthteenth is burdensome enough, but proxy season makes compliance an even heavier chore. Meanwhile, agencies and Congress continue to propose federal solutions to problems that some would prefer to see worked out at the state or company level. Here are key developments as of April 2010.
This column was written by the research staff at the NACD.
SEC Seeks ‘Deeper Meaning’
As directors already know, companies must include new disclosures in this year’s proxy:
- Risk oversight: More information on risk and compensation
- Compensation for directors: Changes to options reporting in the compensation table
- Director qualifications: “Experience, qualifications, attributes or skills” that led to board appointment/nomination—including how a nominating committee “considers diversity in identifying nominees for a director”
- Leadership: Whether and why a company has chosen to combine or separate the roles of chairman and CEO
What directors may not realize is that the Securities and Exchange Commission is on a relentless search for deeper meaning. Based on past trends, the agency will soon be sending letters to companies about their 2010 governance disclosures. Shelley Parratt, deputy director in the SEC’s Division of Corporation Finance, emphasized at an NACD Capital Area Chapter meeting earlier this year that the SEC does not need detailed descriptions of process, but wants “reasons why.”
When a company explains its compensation decision-making processes but does not explain why it made the decisions, Parratt told the NACD audience, the SEC will ask for enhanced disclosure of the analysis.
Dodd Bill Distilled
Even while comments are still coming in to the SEC on proxy access, there is parallel movement on the Hill. Proxy access is one of no less than nine general governance issues proposed by Sen. Christopher Dodd (D-CT), chair of the Senate Committee on Banking, Housing and Urban Affairs. This new phoenix rose from the ashes of the Restoring American Financial Stability Act, originally proposed last year.
Overall, the new Dodd bill contains governance guidance for most financial companies, including investment advisors and/or private equity funds, and last but not least, non-bank financial companies and some bank-holding companies (which are required to have a risk committee). The bill even includes governance instructions for the Federal Reserve System itself. If you are a director of a financial company, it’s probably a good idea to read the entire 1,336-page bill.
Here is a checklist of the more general governance items, starting with the subsection on Accountability and Executive Compensation:
Say on pay: Proxies would have to include “a separate resolution subject to shareholder vote to approve the compensation of executives.” This provision would not limit the ability of shareholders to make additional pay proposals. Their vote would not be binding and could not overrule a decision by the company or its board. This is in accordance with the NACD’s Key Agreed Principles, founded on the basic premise that corporate governance should be determined by the board (assuming legal and listing compliance.)
Compensation committee independence: Compensation committee provisions cover independence, advice, disclosures and funding. The bill mandates an all-independent compensation committee, indicating that any receipt of consulting fees or any affiliations would disprove independence (think Sarbanes-Oxley audit committee independence). Compensation committees would have the right (but not the obligation) to maintain independent legal counsel and independent compensation consultants. In a move many compensation committees would welcome, the bill states that committees would have a right to obtain funding for advice: “Each issuer shall provide for appropriate funding, as determined by the compensation committee in its capacity as a committee of the board of directors, for payment of reasonable compensation—(1) to a compensation consultant; and (2) to independent legal counsel or any other advisor to the compensation committee.”
Showing admirable legislative temperance, the proposed bill also includes rules of “construction” protecting directors’ business judgment. A typical rule reads: “This paragraph may not be construed to …affect the ability or obligation of a compensation committee to exercise its own judgment in fulfillment of the duties of the compensation committee.” Again, this language accords with NACD principles.
Pay vs. performance: In their proxies, companies would have to disclose (using charts if they wish) the relationship between executive compensation actually paid and the financial performance of the issuer, taking into account any change in the value of the shares of stock and dividends of the issuer and any distributions. The relationship of pay to performance requires use of performance metrics. This will be the subject of NACD’s 2010 Blue Ribbon Commission, co-chaired by John Dillon, retired chairman and CEO of International Paper, and Bill White, retired chairman and CEO of Bell & Howell.
Clawbacks: The bill would mandate recovery of erroneously awarded compensation. No listing would be allowed for companies unless they develop and implement a policy on clawbacks and recovery from any incentive-based compensation awarded within the past three years based on an accounting restatement, with or without fraudulent intent.
Disclosure of hedging by employees and directors: This would include prepaid variable forward contracts, equity swaps, collars, and exchange funds designed to hedge or offset any decrease in the market value of equity securities granted to or held by employees or directors.
Excessive compensation by bank-holding companies: A “safe and unsound” tag would be put on banks that pay executives or others pay that could lead to material financial loss to the company. Although this would apply only to banks, if approved, it could spread to other industries, so it should be watched carefully.
The Strengthening Corporate Governance subsection consists of three main parts:
Majority vote: In an uncontested election, each director who receives a majority of the votes cast would be deemed to be elected. If a director of an issuer received less than a majority of the votes cast in an uncontested election, the director would tender the resignation to the board of directors. The board could refuse the resignation but it would have to disclose why. (If the number of nominees exceeds the number of directors, each director would have to be elected by the vote of a plurality).
SEC’s right to mandate proxy access: The SEC would have the right to issue proxy access rules. This has been under dispute, with some saying the SEC does not have jurisdiction in such matters.
Disclosures regarding chairman and CEO structure: These rules would require that the proxy sent to investors must state the reasons the issuer chose the same, versus different individuals, to serve as chairman of the board of directors and chief executive officer (or equivalent positions). Such disclosure is already required by the SEC.
The penalty for not conforming to any of these rules could be delisting—or not getting listed in the first place. But the bill makes it clear that it will give companies time to conform, and that regulators will make exceptions for small-company size.
Even if this bill is signed into law by the time the next issue of NACD Directorship arrives at your door—always possible with this hasty Congress—its real impact will come through the typical Washington fare of rules and technical corrections.
For just-in-time, confidential answers to governance questions, contact NACD’s confidential hotline, ExpressSource, at nacdonline.org (go to “Governance Resources”).
This column was written by the research staff at the NACD.