Elisse Walter

“I want to express my deep gratitude to Mary Schapiro for her steadfast leadership at the Securities and Exchange Commission,” Obama said in a statement released today by the SEC. “When Mary agreed to serve nearly four years ago, she was fully aware of the difficulties facing the SEC and our economy as a whole. But she accepted the challenge, and today, the SEC is stronger and our financial system is safer and better able to serve the American people—thanks in large part to Mary’s hard work.”

Ann Yerger, executive director of the Council of Institutional Investors (CII), also praised Schapiro’s efforts to revitalize the SEC in a statement issued today. “Mary Schapiro deserves high marks for revitalizing the SEC and protecting investors. In particular, she beefed up the agency’s enforcement muscle, steered the SEC through its busiest rule-making period ever and strengthened shareowner rights. Under her watch in 2010, the SEC eliminated uninstructed broker voting in director elections at U.S. public companies, a practice akin to stuffing the ballot box for management, since broker votes are almost always cast as management wants. Mary also bravely championed giving investors a meaningful voice in corporate board elections in the face of enormous, unrelenting opposition from the business community. And despite daunting rule-making deadlines, she ensured that the SEC implemented many provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act as Congress envisioned.”

Yerger also pledged CII’s support for Walter as SEC chairman: ”The Council of Institutional Investors congratulates Elisse Walter on being designated SEC chair and looks forward to working with her to advance the SEC’s important mission as the ‘investor’s advocate’ and to supporting her efforts to make the financial regulatory system more transparent, accountable and responsive to investors.”

In its coverage, The New York Times described Schapiro’s tenure as “bruising.” She agreed to become chairman at a time when the Commission was being roundly criticized for its lax oversight of brokerage firms such as Lehman Brothers, which failed in 2008 and contributed to the worst economic downturn since the Great Depression, and for missing the massive Ponzi scheme carried out by Bernard L. Madoff. The Wall Street investor confessed the fraud to his sons who contacted regulators and Madoff was arrested just weeks before Schapiro was sworn in as chairman.

The SEC posted a list of Schapiro’s accomplishments, which for corporate officers and directors will have myriad ramifications now and into the future. It was on Schapiro’s watch that the Dodd-Frank Act was passed some 36 months ago. Dodd-Frank required the SEC to promulgate hundreds of new rules, many of which had a direct influence on boards.

In addition to modernizing the agency with technology and making structural changes, Schapiro appointed Jeff Heslop to the Commission’s first Office of the Chief Operating Officer and established a think tank-like division dedicated to risk and economic analysis. She also established a controversial new whistleblower program that awards money for good tips.

Walter is a Democrat who became an SEC commissioner in 2008 and briefly served as the agency’s acting leader a year later. She has been a longtime ally and colleague of Schapiro’s. They overlapped at the Commodity Futures Trading Commission and FINRA, where Walter was a senior regulator and lawyer. The Times described Walter as “often the only reliable vote for Ms. Schapiro’s rule-making efforts and is now expected to carry out a similar agenda as chairwoman.”

Michael Goldstein 

However, nothing tops the Senate majority leader, who, upon learning that the U.S. Olympic team uniforms were made in China, wanted to institute a pre-Olympic bonfire fueled by the uniforms a few days before our team left for London. Senator, what would the team wear? Just imagine how great our team would look in front of the world in cut-offs and flip flops. But why stop there? Let’s destroy the team’s running shoes, track equipment, swim attire, rifles and bows and arrows—most of which is manufactured outside of the United States. Outsourcing has now become this year’s sound bite.

Many of you are probably reading this on a computer or mobile device. Think about where that device was assembled. Then ask yourself if you care where it was manufactured or where it was developed.

Like it or not, our economy is global. Some places with a lower cost of living will always provide cheaper labor, but we have the talent that will continue to design the wondrous things the other parts of the world assembles. We need to focus on the development of new products and innovations, and let someone else put them together. The additional profits made by this approach will grow businesses in the United States and, in turn, create more and better jobs.

Last September, I wrote a column titled “A Modest Proposal,” in which I discussed the need to train and educate people for the 21st century. I suggested that repatriating offshore corporate accounts (now approaching $2 trillion) at lower tax rates, as long as a portion of the funds are used to train and educate many out-of-work individuals so they can be groomed for jobs that need skilled applicants.

The repatriated funds could also be used to provide scholarships for talented students interested in the sciences and engineering. A student who applies for a scholarship will be obligated to work for the sponsoring corporation for four years after graduating. This seems to work well right now—just look at our four major military academies.

I mentioned this approach to a key member of the House and was told that we need to overhaul the tax code first. Why? We need something to happen now, or 8.2 percent unemployment will be the new normal. This is unacceptable.

Companies with offshore accounts need to tell Congress, “Let’s get together in a nonpartisan way and get this done on behalf of all of America.”

When the world gathers in London, remember that we are a global family. Outsourcing will continue, but if the United States is ahead in innovating new concepts and designs created by people trained and educated here, we won’t care where or who puts the pieces together.

“Our investigation reveals that there were few lines the executives were willing to cross to win the contract,” said SEC Enforcement Director Robert Khuzami in a conference call on the charges this morning, noting that Siemens executives allegedly approved up to $100 million in illegal bribes.

Recipients of those bribes allegedly included two presidents and cabinet ministers in two Argentinian administrations between 1996 to 2007. Of the funds used in the bribery scheme, approximately $31.3 million were made after March 2001, when Siemens became a U.S. issuer.

“One of the most critical functions of law enforcement is to communicate that businesses are not fools or dupes for obeying the law, we want to reward those companies that refuse to pay bribes. The best way to do that is to root out their competitors that are,” said Khuzami. “Business should flow to the company with the best product and the best price, not the best bribe. Corruption erodes public trust and the transparency of our commercial markets, and undermines corporate governance.”

Siemens, as a company, previously faced similar charges and paid $1.6 billion to resolve them with the SEC, U.S. Department of Justice and the Office of the Prosecutor General in Munich. Lanny A. Breuer, U.S. Department of Justice assistant attorney general for the DoJ’s criminal division, noted the value of Siemens’ assistance in bringing charges against the individual former executives. “It absolutely should be said that Siemens was remarkably cooperative and helpful throughout our investigation,” said Breuer. “Foreign bribery and corruption undermine fair market competition and create instability.”

The individuals charged in this case, according to an SEC press release, are:

• Uriel Sharef  – A former managing board member at Siemens from July 2000 to December 2007. He met in the United States with payment intermediaries and agreed to pay $27 million in bribes to Argentine officials in connection with the DNI contract.
• Ulrich Bock – Former commercial head of major projects for Siemens Business Services (SBS) from October 1995 to 2001. As the officer responsible for the DNI contract, he authorized bribe payments to Argentine government officials.
• Stephan Signer – Replaced Bock as commercial head of major projects for SBS and later became head of business operations and finance at Siemens IT Solutions and Services. He authorized the payment of bribes to government officials in Argentina.
• Herbert Steffen – CEO of Siemens Argentina from 1983 to 1989 and again in 1991, and group president of Siemens Transportation Systems from 1996 to 2003. Due to his longstanding connections in Argentina and Latin America, Steffen was recruited by Sharef and met directly with Argentine officials and offered bribe payments on behalf of Siemens.
• Andres Truppel – CFO of Siemens Argentina from 1996 to 2002. He regularly communicated with Argentine government officials regarding illicit bribe payments and participated in U.S.-based meetings where bribes were negotiated and promised.
• Carlos Sergi – A former board member of Siemens Argentina and a business consultant for Siemens Argentina. His primary role was to serve as a payment intermediary between Siemens and Argentine government officials in connection with the DNI contract.
• Bernd Regendantz – CFO of SBS from February 2002 to 2004. He authorized two bribe payments totaling approximately $10 million on Siemens’ behalf.

Harry Cendrowski (l) and Walter McGrail (r).

Whistleblowers often face significant pressure to remain quiet rather than report unlawful actions.  Though many whistleblower laws including Dodd-Frank contain anti-retaliation protection, evidence demonstrates that whistleblowers risk, in the words of the Senate Banking Committee, “committing ‘career suicide.’” Recent studies, including those highlighted in testimony before the House Financial Services Subcommittee on Capital Markets, indicate between 82 percent and 90 percent of whistleblowers are fired, quit under duress, or are demoted. For individuals working in a geographical area with few employers, or in an industry with little competition, the effects of whistleblowing can be substantial.  Whistleblowers may find themselves ostracized by local, regional, and national businesses for their actions. They may also face adverse social consequences.

In light of these consequences, whistleblowers often desire retaliation protection and anonymity.  Whistleblower provisions of Dodd-Frank provide for anti-retaliation protection and state that the SEC will protect the identity of the whistleblower to the largest extent possible; however, a whistleblower must satisfy numerous conditions to receive these benefits.  For example, a recent court ruling, Egan v. TradingScreen, Inc., found that a whistleblower must provide information regarding unlawful actions to the SEC in order to state a retaliation claim.  Whistleblowers reporting information solely to boards of directors and executives of their employing organization may not necessarily receive retaliation protection in spite of Dodd-Frank’s encouragement of such actions.

Additional conditions imposed by Dodd-Frank effectively incentivize individuals to report unlawful, tax-related actions to the IRS as opposed to the Commission.  For example, according to the SEC:

“…[Dodd-Frank] would authorize disclosure of information that could reasonably be expected to reveal the identity of a whistleblower…For example, in a related action brought as a criminal prosecution by the Department of Justice, disclosure of a whistleblower’s identity may be required, in light of the requirement of the Sixth Amendment of the Constitution that a criminal defendant have the right to be confronted with witnesses against him.”

Other Dodd-Frank provisions seemingly protect the confidentiality of whistleblowers in civil actions brought by the SEC or related government body.  However, because numerous exceptions exist to these confidentiality provisions, a whistleblower would likely assume he would eventually be exposed.  In contrast, the IRS can initiate an audit of tax records without likely subjecting the whistleblower to the Sixth Amendment.  Audits occur in the normal course of business and, barring appeal, do not require legal action or disclosure of a whistleblower’s identity.  As such, a whistleblower with knowledge of unlawful tax-related actions would likely select to report the issue to the IRS as the Service may be better able to protect his identity.  For example, the IRS recently paid a whistleblower $4.5 million for providing a tip that netted the IRS $20 million in taxes and interest.  The identity of the whistleblower, who worked for a Fortune 500 professional services firm, remains anonymous.

In addition to anonymity concerns, whistleblowers are monetarily incentivized to report unlawful actions to the IRS.  Under Dodd-Frank whistleblower provisions, the SEC must pay an award of between 10 and 30 percent of the amount recovered to eligible whistleblowers.  Section 7623 of the Internal Revenue Code, however, “mandates a whistleblower award of between 15 and 30 percent of the amount recovered” by the IRS.  While the upper bound of the potential bounty received by a whistleblower is 30 percent in both instances, the IRS is required to minimally pay a 50 percent larger award than the SEC for information resulting in successful enforcement of unlawful actions.

Whistleblowers may also turn to the IRS over the SEC due to the concept of materiality.  In enforcing securities laws (including the Sarbanes-Oxley Act of 2002), the SEC is largely concerned with matters that are material to financial statements, as these matters may change, according to the Financial Accounting Standards Board, “the judgment of a reasonable person” relying upon them.  The concept of materiality thus constrains the SEC’s actions:  if the SEC feels an item is immaterial, the Commission may forego investigation of the issue, and the whistleblower will not receive a monetary reward.  The concept of materiality, however, largely does not apply to tax assessments.  Thus, a whistleblower with knowledge of tax issues is incentivized to report the issue to the IRS as the Service is unconstrained by the concept of the materiality; the IRS may elect to investigate an issue that the SEC would otherwise not investigate.

Lastly, the IRS’s organizational structure, with its separate whistleblower office, may incentivize potential whistleblowers to report their concerns to the Service as opposed to the Commission. Currently, the SEC lacks an independent whistleblower office to handle tips.  While Sean McKessy was recently tapped to head the SEC’s whistleblower office, the office remains under the direct supervision of Robert Khuzami’s Division of Enforcement:  McKessy does not report directly to SEC Chairman Mary Schapiro.  On the contrary, the IRS has a separate, independent whistleblower office, which serves as the central repository for all whistleblower claims.  The director of this independent office reports to the IRS Commissioner, decreasing the possibility that a claim remains uninvestigated by lower-level IRS managers.  This difference in structure between the SEC’s whistleblower office with that of the IRS was highlighted in a May 10, 2011 letter by Sen. Charles Grassley to Mary Schapiro.  Sen. Grassley is the author of numerous whistleblower protection statutes, including the 2006 amendments to the IRS whistleblower program and Sarbanes-Oxley whistleblower protections for employees of publicly traded companies.

While numerous politicians and practitioners have applauded the whistleblower provisions of Dodd-Frank, these provisions are less attractive to potential whistleblowers than those already existing in the Internal Revenue Code.  With respect to tax-related issues, a whistleblower is likely incentivized to report issues to the Service rather than the Commission due to greater perceived anonymity and monetary rewards; a lower materiality threshold for tax assessments than financial statements; and the administrative structure of the IRS and SEC’s whistleblower programs.  Unless these provisions are substantially modified, Dodd-Frank represents at best an incremental step in incentivizing whistleblower activity for tax-related issues.

Harry Cendrowski is a founding member and Walter McGrail is a senior manager of Cendrowski Corporate Advisors.

Senator Tim Johnson

The Senator recently responded to questions submitted by NACD Directorship’s Jeffrey M. Cunningham on his efforts to improve the economy, protect Dodd-Frank and reform the U.S. housing finance structure.

What did the 2010 elections mean from a political perspective?
The 2010 election was obviously not the best cycle for Democrats as a whole, but these things swing back and forth. Voters elected a Republican House of Representatives and a Democratic Senate, so neither party has a mandate. I don’t know what 2012 will bring, but I know that the American people expect their elected officials to work together to help get the economy back on track and create jobs instead of playing partisan political games.

What do you make of the House efforts to repeal or change Dodd-Frank?
Despite the fact that Americans lost millions of jobs, millions of homes and trillions of dollars in wealth, Republicans apparently believe we were adequately protected during the financial crisis. Efforts to tear down Dodd-Frank are attempts to go back to the days of too big to fail banks, backroom derivatives deals and risky subprime mortgages. I think the American people want Congress to focus on the future and on creating new jobs, rather than trying to dismantle this historic reform.

You have said: “I hope that in the great tradition of this body we can disagree without being disagreeable.” How?
I have always believed that part of my job as a Senator is to work to build consensus, and with a divided Congress that is more important than ever. Neither party has a monopoly on good ideas. The American public wants us to find common ground that creates jobs, grows the economy and deals with the real challenges we’re faced with.

Why was proxy access a controversial measure even in committee?
As with many parts of the bill, there was a lot of disagreement over proxy access because there were legitimate concerns raised on both sides of the issue. In the end, Congress gave the authority to set proxy access rules to the SEC. The SEC’s proposed rule is currently the subject of litigation, and I am closely monitoring the situation. It’s important that a balance be struck between shareholder rights and board autonomy.

To what extent is Fannie Mae and Freddie Mac a focus for the SBC?
Housing finance reform is a top priority, and I have already held three hearings on the topic. It is a very complex issue, so we need to examine it thoroughly and build bipartisan consensus in order to move forward on legislation.

How do you feel about the Financial Stability Oversight Council and its “too big to fail” law?
Dodd-Frank ended too big to fail and ensured that American taxpayers will never again be forced to throw billions of dollars at Wall Street to save firms that run the risk of bringing down our entire economy. The Financial Stability Oversight Council (FSOC) is an essential component of the law, because the systemic problems we saw in the financial crisis cut across the traditional boundaries between regulators. The FSOC has improved coordination and increased transparency between agencies, and I am confident it will help better protect the stability of our financial system.

It’s important that shareholders have a say on executive compensation, and Dodd-Frank ensures that they do. I have no doubt that talented and successful executives who deliver value to shareholders will be appropriately compensated.

We hear that public accounting firms will be a focus of your efforts.
Reliable, accurate and transparent accounting is clearly vital for investor protection and confidence. This is an important issue that the Committee has and will continue to monitor, most recently at a subcommittee hearing in April.

Do you feel the Dodd-Frank ‘say on pay’ provision gives investors adequate safeguards?
The SEC’s final rules regarding shareholder votes on executive compensation are only a few months old at this point. We should give the new rules adequate time to work before jumping to conclusions or introducing new legislation.

What suggestions do you have for setting CEO compensation?
It’s important that shareholders have a say on executive compensation, and Dodd-Frank ensures that they do. I have no doubt that talented and successful executives who deliver value to shareholders will be appropriately compensated.

What concerns you most about funding for the SEC?
It is vitally important that both the SEC and CFTC get the resources they need – the 2008 economic crisis showed us the dangers of regulatory shortfalls. The Wall Street reform bill strengthened regulators ability to police the financial system and help prevent another financial crisis. These two important regulators serve on the front lines investigating fraud and abuse, and it is imperative that they are provided with the necessary resources to do their jobs and protect American taxpayers and investors.

What do you hope your legacy as banking chair will be?
I am focused on doing the best job I can. My top priority for the Committee is to support the nation’s economic recovery and promote job growth, and my agenda as chair reflects that.

Leading the list of contenders identified by Delaware insiders to succeed Chandler is Vice Chancellor Leo E. Strine Jr., the court’s most senior judge. Prior to being appointed to the court in 1998, Strine served as counsel to former Delaware Gov. Thomas R. Carper, now one of Delaware’s two senators, and prior to that as a litigator for Skadden Arps.

Other possible candidates identified in media reports this week include Sam Glasscock III, chancery court master; Delaware Superior Court Judge Mary M. Johnston; and Kevin F. Brady, partner at Connolly Bove Lodge & Hutz in Wilmington, Del.

The process of choosing Chandler’s successor got underway on Tuesday when the Delaware Judicial Nominating Commission (JNC), chaired by Andre G. Bouchard, managing partner at Bouchard Margules & Friedlander, issued a public notice soliciting candidates. The court is required by the state constitution to be bipartisan and all candidates must be Delaware residents. Candidates must submit a completed questionnaire no later than noon, May 13. They would be interviewed by the JNC which refers all finalists to Gov. Markell who then recommends one candidate to the state Senate for approval.

Writing on his blog, Delaware Corporate and Commercial Litigation Blog, Francis X. Pileggi notes that “the history of judicial selection supports the conventional wisdom that any vacancy (or vacancies) on the Delaware Court of Chancery will be filled promptly by some person who will be selected by the JNC, appointed by the Governor, confirmed by the Delaware Senate and installed on the court by the end of the regular legislative session on June 30.”

The 60-year-old Chandler notified the Delaware governor he plans to retire to seek opportunities in the private sector.  His last day on the court will be June 17.

In March, and again on April 15, prominent law firm Wachtell, Lipton, Rosen & Katz proposed in its comment letters to the SEC that the current 10-day reporting deadline be shortened and the definition of beneficial ownership be expanded. “We believe that the current reporting regime fails to fulfill its stated purposes,” Wachtel lawyers wrote in the letter filed with the SEC on April 15. The law firm believes that investors, issuers and the market as a whole would benefit from such changes.

“There is no valid policy-based or pragmatic reason the purchases of significant ownership stakes in public companies should be permitted to hide their actions from other shareholders, the investment community and the issuer; indeed the need for transparency, fairness and equality of information in our financial markets has never been higher,” Wachtell reasoned.

“Changing the 10-day disclosure rule is part of the larger project that the SEC is undertaking to modernize the rules. Dodd-Frank has a provision that gives the SEC the authority to close the reporting window and it is on the slate. We propose that the period is changed to one-day. Our most recent comment letter reaffirms our call for a broader review of the shareholder disclosure system,” says Eric Robinson, Partner in the corporate practice at Wachtell.

This argument is not new. In fact, many different groups have raised concerns over the 43-year-old reporting rules, including the SEC. Michele Anderson, chief of the SEC’s Office of Mergers & Acquisitions, told MarketWatch that she has plans to recommend that the number of days activist investors have before they must publicly disclose they have a five percent stake in the company be shortened. Existing timeframes for disclosure have been in place since 1968 as part of the Williams Act.

“The staff believes that period may be outdated, it has been in place for over 40 years now, and we have concerns that it may provide opportunities for investors to obtain a sizeable stake in the company before they are obliged to make any public disclosure,” Anderson said in February.

Investors are now able to execute trades in seconds and it is possible to prepare ownership reports in very short periods of time. Many investors can—and do— exploit the 10-day reporting gap to secretly acquire more stock in the company, hidden from the issuer and market at large.

Bruce Goldfarb, founder and CEO of Okapi Partners, a proxy solicitation firm, sees pros and cons on both sides. “I think it will mean activists will find that it is harder to quickly accumulate a position and for investors to build up an investment before there is additional market movement. Some investors purport this to be a real issue with activism. I think there is some truth to that.”

Some market participants complain that the lag in reporting requirements allows an investor to accumulate large voting interests before disclosure is made that would impact the price of the stock and that this is not fair.

“I think it will impact some investors in their interest and ability to rapidly accumulate shares at a price they believe to be good value. I agree with investors that say expediting the reporting timeframe will impact their ability to accumulate a large position. Without a value judgment of whether that is a good thing or a bad thing there is absolute truth that faster reporting will move markets. We have already seen that when people file a 13D. It has an effect depending on who the investor is and what position they are taking. So if you are accelerating that follow-on effect it is going to have an impact,” explains Goldfarb.

With changes to the director election process these reporting requirements can be of real and significant importance to directors. “I have empathy for companies that are trying to figure out who owns their shares. The process as it stands now does not help issuing companies or other investors to have an understanding of who the owners are of a company. If you are a director and trying to act in the best interest of shareholders yet you don’t always know who those holders are, it creates a serious conundrum.”

Changing the system is not without problems. Some investors feel that the current reporting regime is burdensome and compliance too time consuming. Even though trading platforms have accelerated and news is distributed faster, the 13D process hasn’t kept pace. It is, in the eyes of some investors, faster to accumulate the shares than it is to report exactly what holdings they have.

“I have empathy on both sides and I think that while the board may appreciate the changes, I don’t know how well received it will be by the investors community. Not just by activist funds but by traditional investment management firms that are heavily burdened sometimes by the reporting requirements,” cautions Goldfarb.

In an April 15 release the Commission left unchanged reporting requirements under 13D(c) for derivatives such as convertible instruments (that can result in accumulating a “stealth” voting position).

While the SEC made no change at this stage to security-backed swaps it is still considering shorting the disclosure window as part of a broader review of beneficial ownership disclosure.

Brendan Sheehan is the editorial director of NACD Directorship and Directorship.com

When Wall Street leaders and other denizens of the boardroom are brought before Congress and demonized, it appears the scales are tipped against business executives, regardless of the facts. Many have mentioned to me that they are brought there solely for the browbeating and broadcast rights. Although in light of this year’s election coverage, these two cases will most likely be settled early or drawn out beyond, the folks at home will have a chance to see how the system works when the tables are turned.

Jeffrey  M. Cunningham is a frequent speaker and writer on governance topics and the boardroom. He is  managing director and senior advisor to NACD and has served as a director or chairman of 10 public company boards.

With the signature of President Barack Obama on July 21st, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 is now the law of the land. For boards in all industries, not just in banking, this broad new law has struck like a governance earthquake. There will be strong aftershocks as regulators work on implementation on a timeline that ranges from immediate to five years from now.

So what’s in the law? Thanks to ongoing coverage by NACD Alliance Partner Weil Gotshal and others, most directors are by now  familiar with key provisions of this massive legislation. Still, hidden in the law are more governance shockers—such as a superclawback provision in Title II. Here’s a guide to key provisions of the law and what to do about them.

Title I: Financial Stability
Mandating risk committees for some financial institutions. The Board of Governors of the Federal Reserve System will require certain financial institutions to establish a risk committee. The provision applies to any publicly traded non-bank financial company supervised by the Board of Governors and to any publicly traded bank-holding company with consolidated assets of $10 billion or more.  The board-level risk committee will be responsible for the oversight of the enterprise-wide risk management practices of the company; will include the number of independent directors the Board of Governors recommends (based on the nature of operations, size of assets and other appropriate criteria related to the company); and will include at least one risk management expert with experience in “identifying, assessing and managing risk exposures of large, complex firms.”

Next steps: Find a good risk committee charter and adapt it for your use. Take advantage of the work and documents of existing risk committees in successful institutions. Also, make sure the full board continues to oversee risk. This topic is too critical to delegate entirely to a committee.
Audit committees should continue their active oversight of financial reporting risk.

Title II: Orderly Liquidation Authority

Firing and superclawback power for the FDIC. Under this title, especially section 210, the Federal  Deposit Insurance Corporation (FDIC) has the power to act as the receiver for insolvent financial companies, including publicly held bank holding companies and non-bank financial companies—a broad term that could conceivably cover any financial firm. The law states that the FDIC may “disaffirm or repudiate any contract or lease to which the covered financial institution is a party” if the Corporation finds it “burdensome.” Furthermore, the FDIC may recover “compensation” from “any current or former senior executive or director substantially responsible for the failed condition of the covered company.” There’s a two-year statute of limitations, except for fraud, where there is no time limit. The FDIC “shall promulgate regulations to implement the requirements of this subsection, including defining the term ‘compensation’ to mean any financial remuneration including salary, bonuses, incentives, benefits, severance, deferred compensation or golden parachute benefits and any profits realized from the sale of the securities” of the company. When NACD Directorship spoke to Weil Gotshal Counsel Heath P. Tarbert in Washington, D.C., he warned that almost any financial firm might be vulnerable to FDIC action under this broad provision—including hedge funds.

Next steps: Directors of financial institutions need to keep a close watch on the implementation of these provisions, bearing in mind that even if directors do everything in their power to avoid insolvency, failure can occur due to outside forces beyond their control. A combination of volatile markets, changed accounting rules and changed reserve requirements can lead to findings of insolvency despite adequate oversight by the board. Given the current aggressive stance of regulators, combined with the current weak economy, directors of financial institutions should consider the possibility of insolvency and a resulting loss of past compensation. As such, they would be prudent to consider their pay to be entirely at risk and should  plan accordingly.

Title IX: Investor Protections and Improvements to the Regulation of Securities

Bounties for whistle-­­­­­­­­­blowers. The whistle-blower provision goes well beyond the one in Sarbanes-Oxley (SOX), which merely protected whistle-blowers. This provision offers a reward of between 10 and 20 percent for a tip that leads to sanctions of $1 million or more. The tipster, who may be anonymous to the company and known only to the Securities and Exchange Commission (SEC), stands to receive at least $100,000.

Next steps: Use this provision as the catalyst for reinvigorating your company’s ethics training program. This can deter not only truly unethical behavior, but also frivolous complaints.

Mandated shareholder approval for compensation— “say on pay”—and golden parachutes. This provision goes into effect for companies at their next annual shareholder meetings. At least once every six years, shareholders must vote on the frequency of this pay referendum, which the law says must be held at least every three years. Moreover, in any proxy or consent solicitation material in which the shareholders are asked to approve M&A activity, the company must disclose any and all compensation (including the total value) expected to be paid to executive officers based on the proposed M&A activity. This proxy must also include a non-binding shareholder vote to approve these compensation agreements. The SEC may exempt small companies from these provisions.

Next steps: Work proactively with your corporate secretary to prepare for this issue at your next annual meeting. Address the subject of pay referendum frequency in your proxy materials. Consider the pros and cons of frequent vs. infrequent say-on-pay votes, bearing in mind that the most important part of executive pay is long-term incentive pay, which is often calibrated to pay out in three years or more. Remember, because the vote occurs after the launch of a plan, and because all it says is “no,” its value is more symbolic than informative. Effective shareholder communications remain extremely important.

Independent compensation committees. All companies listed on a national securities exchange must have a compensation committee composed entirely of directors deemed independent. The securities exchanges will set the guidelines for determining independence. The consultants selected by the compensation committees must be independent as well. The exchanges may choose to exempt companies from this requirement based on size and other factors.

Next steps: Boards can define independence stringently for their compensation committees now, without waiting for outside definitions. Most companies now use existing definitions from the exchanges (November 2003 listing rules implementing SOX) or from the Internal Revenue Service (implementing the $1 million cap on tax deductibility two decades ago). However, the SEC is likely to narrow the definition. In anticipation of the SEC’s rule, consider implementing the SOX Section 301 definition of audit committee independence. This rule assumes that the independent director is not an employee or related to an employee. But furthermore it states that the independent director must not accept consulting fees and must not be affiliated with the company or its subsidiaries.

Increased compensation disclosures. When disclosing executive compensation in the proxy, companies must also discuss the relationship between compensation already paid and the financial performance of the company, “taking into account any change in the value of the shares of stock and dividends of the issuer and any distributions.” Companies must also disclose the median annual compensation of all employees of the company, excluding the CEO, the total annual compensation of the CEO and the ratio between the two.

Next steps: Allocate agenda time to define corporate performance in a way that is meaningful to the company. As noted above, the law says boards must include stock price performance and dividend payments. However, boards would be unwise to limit their definition of corporate performance to these indicators.

One of the great lessons from the recent financial panic was that stock price is not always a fair indicator of value. Indeed, the most useful definitions of “financial performance” include additional factors, such as operating profits, cash flow and total shareholder return (TSR) during a stated investment period, according to recent surveys by NACD, Pearl Meyer & Partners and James F. Reda & Associates. Furthermore, boards should not let this regulatory emphasis on financial metrics distract them from other metrics, such as improvements in health, safety and the environment.

Guidance on both financial and non-financial metrics appears in the report of the NACD Blue Ribbon Commission on Performance Metrics to be released in October 2010 and featured in the next issue of NACD Directorship magazine.

As for the median compensation disclosure, boards should not wait to be surprised by the number come proxy time. If you are not already receiving this number now, ask for it. If the number suggests that the CEO is being overpaid in relation to employees, review pay plans, check peer numbers and ask: Is this perception or reality? If it is perception, explain it to your stockholders. If it is reality, work to change it.

Clawbacks. If a company is required to file an accounting restatement due to the material noncompliance with a financial reporting requirement, the company must recover all incentive-based compensation related to the incorrect statement paid to current or former executives within the three-year period before the restatement.

Next steps: Compensation committee members can study the balance of base salary to incentive compensation in light of this new provision and the other compensation provisions, such as say on pay and pay for performance, in the new law. Incentive pay—especially long-term incentive pay—is vitally important. But boards should avoid placing so much in at-risk incentive pay that it will have a demotivating rather than motivating effect:  honest, hardworking managers should not experience rebuffs or repossession due to accounting technicalities.

Meanwhile, audit committee members should be more vigilant than ever when reviewing financial statements to make sure that the accounting treatments chosen are appropriate and that no red flags appear. This will reduce chances of restatements due to  error or fraud. If there is a restatement, comply with the clawback provision but don’t stop there; work to restore trust in the board’s judgment and integrity.

Employee or director hedging. Proxy materials must disclose whether any employee or board member of the company holds or was granted any financial instrument to hedge against a decrease in the value of the company.

Next steps: Boards can go one step further and implement a policy banning this behavior. It is not good to allow a director or an employee to bet against the company by shorting stock (benefiting from a decrease in share price). They are there to foster prosperity, not to profit from decline.

Increased compensation oversight for the financial industry. Financial institutions must disclose all incentive-based compensation of their employees. Federal regulators can enact regulations or guidelines to prohibit any type of such incentives that they consider excessive or that could lead to financial loss to the institution.

Next steps: If you serve on the board of a publicly held bank, review the disclosures your bank made about compensation risk and the pay performance link  (both already required under proxy rules). If you determine that the compensation awarded fails to motivate long-term value but instead motivates risky behavior then work to change it.  If, on the other hand, the pay seems appropriate, be proactive in communicating its value to minimize the chance of a government ban.

Broker no-vote. The law also includes elimination of broker voting on say on pay—extending a previous ban on broker voting in director elections. Now a broker is prohibited from voting a proxy for director elections, executive compensation or any other significant matter without instructions from the beneficial owner.

Next steps: Build better relations with your retail investors. For guidance, see the materials of the Shareholder Communications Coalition (shareholdercoalition.com) and by Broadridge (shareholdereducation.com/proxy_process.asp).

Proxy access. The SEC is given the authority to create rules determining procedures pertaining to proxy access. The SEC may exempt small issuers from these rules.

Next steps: Keep current through your advisors and NACD on what the proxy access rules say. Currently, proposed standards range from 1–5 percent and one to five years. NACD’s comment letter on the pending rules suggest a 5 percent holding for two years. (A flash survey conducted at the time of the comment letter revealed that most NACD members supported a 5 percent percent threshold, but were less concerned about time held, with responses clustering at one, two and three years.)

Board leadership structure disclosures. Companies must disclose and explain their choice of board leadership structure, and whether the roles of the CEO and chair position are combined or separated.

Next steps: Companies are already making disclosures about their leadership structures in response to the proxy disclosure enhancement rules that became effective for spring proxy season 2010. Now, they can see the messages of other companies—not just peers, but any well-governed companies. Disclosures vary. Good governance is doing what is right for the company.

NACD has developed a template for enhanced governance disclosures, which can be requested via resources@NACDonline.org. For general governance guidance, the NACD’s Key Agreed Principles to Strengthen Corporate Governance for U.S. Publicly Traded Companies can be accessed at NACDonline.org.

This week, we began the House/Senate conference on what is a massive and far-reaching piece of legislation, which, if it passes, is going to fundamentally restructure the way we do business in this country for years to come. I’m sorry to report that what I see in the legislation moving through Congress is not based on the tradition of opportunity, innovation, competition and personal responsibility that’s made us the strongest and most resilient economy in the world.

President Obama says—and you know, I agree with him—that government cannot and should not replace businesses as the true engine of growth and job creation. So you would think that he agrees with my philosophy. However, if you look at the policies of the Obama administration, they all elevate the role of government and diminish the rights of individuals and companies to make choices for themselves.

If you look at the Democratic members serving in Congress, and many of them are friends of mine, their approach to corporate governance is somewhat akin to Hillary Clinton’s “It Takes a Village.”  And I’ve never thought that a village is a very good way to run a corporation. I believe that management and the board of directors ought to run it and, through them, the shareholders.

If there’s nothing else I say today, this would be my message to you: you can’t have an economy based on free markets and capitalism, and at the same time have rules that are more appropriate for a government-managed and government-controlled economic system.  When you cross that Rubicon of the government intervening day-to-day in corporate decisions, investing in corporations, guaranteeing their obligations and bailing them out, you inevitably move toward a command-and-control economy.

You can’t have an economy based on free markets and capitalism, and at the same time have rules that are more appropriate for a government-managed and government-controlled economic system.

Since Sarbanes-Oxley was enacted, boards of directors have faced greater scrutiny, and that was good. Corporate boards are smaller, far more independent, and more attentive to shareholder interests as clearly demonstrated by the steady decline in CEO tenure. All of these governing changes are welcome and market driven. Well, maybe not all are welcome, but when you have a market-driven approach, it’s always a better solution.

Whenever I speak about problems in Washington, I worry that my remarks may seem overly pessimistic. In fact, I have great confidence in our country and our economy. Our strength is our people, and they will provide the strength to the world if we can just let government get out of the way. If you can count on nothing else about this legislation, there will be unforeseen consequences and collateral damage that will course through the economy like shrapnel.

The 26th chairman of the Securities and Exchange Commission (SEC), Harvey Pitt  warns of the perils of legislation that is “too big to succeed.” What follows is an edited transcript of Pitt’s remarks made at the NACD Directorship Forum just prior to the passage of Dodd-Frank.

George Bernard Shaw once cynically observed that the only thing we ever learn from history is that we never learn from history. Given our current severe economic crisis, I hope Shaw is proven wrong. We have to learn from recent history and replace our broken regulatory system with more effective techniques and better tools to combat the inevitable next crisis we’ll confront. Yes, I said the next crisis. And I’m sorry if I sound unduly somber. I think of myself as a glass-is-half-full kind of guy. But there’s no doubt in my mind that we’ll be confronting our next crisis before far too long.

The only certainty, apart from the fact that there will be a next crisis, is that it isn’t going to look anything like our most recent crisis. And that is what makes the past 18 months so disappointing. We’ve spent over $1 trillion withoutmaterially improving the regular and systematic availability of necessary credit, especially to mid- and small-cap firms, or ending the self-perpetuating cycle of job losses, followed by decreased consumer spending, followed by corporate retrenchments and spending, followed by additional job losses.

What’s worse, the bloated regulatory reform proposals about to become law assure us only of two things: nobody in Congress has actually read them and the sponsors of the legislation clearly aren’t environmentalists. I have several concerns with these proposals. First, forget about being “too big to fail.” These bills are too big to succeed.

The bills effectively create preferred financial services firms, which in my view will distort competition. More to the point, they address last year’s crisis, and they add new layers of bureaucracy, not fewer. They also give the SEC authority it isn’t going to be able to implement successfully, while effectively stripping it of some existing authority.

Now, this isn’t to say that we shouldn’t outlaw improper conduct. But the only way to effect sustainable change in others is if we can get them to embrace change from within. Establishing standards of conduct and imposing serious consequences for unacceptable behavior can help those who are regulated summon the will to change, and the discipline to sustain that change. But merely prohibiting dangerous conduct by itself can’t, and won’t, produce sustainable change, even if it were possible to identify for all time what conduct we should consider to be dangerous.

Indeed, that’s what’s really wrong with our approach to legislation and regulation. Government issues edicts, and then we, who have to live with those edicts and abide by them, lament the twin flaws of our regulatory system. First, the ineluctable failure of some to abide by those edicts, and second, government’s inability to prevent those failures from occurring, or discover them timely when they do.

What we needed two and three years ago, and still do need, is legislation addressing three critical failures of our regulatory system. First, what is needed is a steady stream of significant data, furnished by anyone who has a significant impact on our capital and financial markets. Second, make it mandatory for the government to analyze that data and disseminate it to the markets in real time. And third, authorize the government to set tripwires so potentially significant trends can be delayed or halted while the government figures out whether those trends are dangerous.

The ongoing economic crisis, and the parade of horribles leading up to it, actually tells us what we need to know if only we’d pay attention. Famed cartoonist Walt Kelly summarized it best in his immortal Pogo quote, “We have met the enemy, and he is us.”  Years later, Kelly explained that this message reflected his view that all of us are responsible for our myriad pollutions—public, private, and political. Unless and until we get that, we simply don’t get anything. And this plays out on many levels.

Let it be said that Brian Breheny is a good sport. He gamely agreed to present his own view of the agency’s recharged agenda under Chairman Mary Schapiro before being questioned by the panel of former SEC commissioners. In introductory remarks, Breheny implored directors to engage shareholders and not be fettered by Regulation FD, which he said, “was never intended to stand in the way of those conversations. Are people using the regulation as an excuse? Are you okay with that?”

To open the panel discussion, Edwin S. Maynard asked for reaction to what was then proposed financial reform legislation. What’s being promulgated is what Paul Atkins called a “trade union agenda” and the federalization of governance initiatives such as say on pay, majority voting, clawbacks of executive compensation and proxy access that are best left to the discretion of the states. Atkins warned that increased regulation could thwart the creation of jobs by constraining investors. “Will we finally reach the straw that breaks the camel’s back with respect to public markets, where it’s just completely unattractive to become a public company anymore, or it’s cheaper and easier to go elsewhere to raise funds?”

The best hope, said Annette Nazareth, is “that we end up with legislative provisions that are not so prescriptive that they can be dialed up or down by regulators through notice and comment rulemaking. Frankly, if you look at some of these provisions and you reverse engineer where some of the banks are today, about two thirds of them would not be in compliance. So that’s a real problem. We have to hope that through the conference process that some rationality prevails.”

“Everyone now knows the SEC and that has made the environment more difficult for directors,” Richard Roberts said. “When I worked at the SEC–and I’m from Alabama, originally–nobody knew who the SEC was. Now, everybody knows who the SEC is, and it’s not necessarily a good thing…but that’s the environment that we’re all in. Directors are thrown into that environment, too.  So folks know who you are.  Your responsibilities are going to be much more difficult.”

Part of that changed environment relates to proxy advisors. In response to a question from the audience, Breheny said that the SEC intends early next year to issue its study and concept release on proxy advisory services and whether they should be further regulated: “We can disagree on the role that people play and the cost and how the process is working, but I really do hope that when it gets out that we’ll have at least educated everybody so we can focus on the issues.”

Or let’s not.

As CEO Lloyd Blankfein’s testimony on the Hill today will undoubtedly show, this is a story better told in the business section, not the front page. Unfortunately, his comments may even raise the stakes but in all probability he will not be given the forum to state the facts–which can only be seen in the context of what I will call the American Mirror–as we stare at ourselves we see should see our political leaders.

Goldman Sachs’ trading desks, like desks all over Wall Street, are in the business of moving products into smart, greedy hands because that produces the best outcome for investors. The hedge funds, or hedgies, play the industrial strength version of this game, working angles that only a rocket scientist could love. Goldman’s role in these trades is to deliver not to debate. At the same time they are delivering, the firm may have a sense of a skewed supply/demand imbalance and may make a judgment on those facts for themselves or other clients. But if one hedge fund or bank is working to deepen exposure to a particular investment class, another gives the signal to lighten up. This is what happens every day on Wall Street. You take the trade or you don’t.

The Goldman eclipse: It was no accident the SEC publicity machine issued  release #59 about their Goldman investigation before they later issued release #60 the same day about their incompetency in the Allen Stanford Ponzi case.

When the SEC charged Goldman with fraud on Friday, April 16, 2010, few outside of the media understood the significance of why that day was chosen. Not only was it the same day the Inspector General announced the SEC’s failure in the Allen Stanford Ponzi scheme case, but it was a “no news” day. Rarely does a company announce anything of magnitude on a Friday. This is because journalists are wrapping up their articles for the week, and more importantly in this case, Goldman would be caught off guard with no time to prepare. While the company stewed, the weekend pundits had a field day, and by Monday the firm was on the defensive. You thought the “Dirty Tricks” team went away with Nixon.

“It takes a cynic” to see how this would mightily help the President in his crucial objective for the American public–to win the upcoming mid-term elections. The Obama administration announced the President’s War on Wall Street only two days later–acknowledging the helpful assist from the SEC. Having dropped the healthcare ball, the next move for this election season was to stick a fork into the heart of Wall Street and ride that public anger–all the way through to November. Goldman partners are huge contributors to the Democratic party, ironically. Yet, the politicians don’t fret. They know that soon when this is over, they’ll come back. Perhaps that is why Chuck Schumer is so quiet.

Now watch for the piling on from all sides. This will be in the headlines for another three weeks and the investigation, well, at least until November. The firm will be pilloried by a media that lacks the resources and the incentive to get the real story. Maybe an Andrew Sorkin or a Charlie Gasparino will sense the lack of oxygen in the room and let in some air. Meanwhile, competitors will both be shorting the company and talking trash to the client side. The good news is the company’s franchise is still unassailable. Goldman will be tarnished by the publicity but their leading role in the global banking sector remains intact.

It is a disturbing prospect. American business leadership has the knack to take body blows, apologize to everyone, and find the stamina to move past and recover. For that we should be collectively thankful.

Jeffrey M. Cunningham is a frequent speaker and writer on corporate governance issues. He has served as a director of ten public companies, four of them as non executive chair. The comments and opinions shared in this column are his personal viewpoints, and do not reflect the opinions of NACD Directorship.

Let me talk about what I think is going to happen without healthcare reform, because I actually think the healthcare system is going to change with or without healthcare reform. All of us on corporate boards recognize that healthcare reform will affect risk assessment, benefit cost, taxes and personnel management.

• Second, we need to eliminate the fee-for-service payment system.

• Third, I think doctors increasingly are going to become employees of healthcare systems. They want stability in their income, which will allow hospitals and healthcare systems to get a more integrated care system. So expect some payment reform to go on, with the insurance companies desperately trying to figure out a way to get around some of these costs because employers are pressing them to slow down the growth of healthcare costs.
• Fourth, I think there’s going to be a lot of work on the fraud issue. There are billions to be recaptured. There are a lot of areas where the government could recapture significant money in fraud and I think with our much more sophisticated computer systems that there’s going to be bipartisan consensus to go after fraud—big time.

If you ask Americans where they think the costs are in healthcare, they say fraud and pharmaceuticals. They don’t say you need integrated healthcare systems or any of the things that the experts say. You can expect bipartisan consensus, at least on fraud, but I’m not as sure about the second one because of the power of big pharma to influence the direction of negotiations.

We’ll see a lot more innovation in alternative delivery systems. That includes what you’ve already seen. Even though the numbers are low and it doesn’t look like they’re really turning a big profit yet, don’t underestimate these clinics in Wal-Mart, Walgreens and CVS. Depending on the scope of practice rules in the state, they have to have doctor supervision. They’ll get you an appointment with a doctor in 24 hours. These sytems are convenient and  they’re very risk averse; they’re only doing things where there is a clear standard of practice that nurses can handle. The fact is that America’s advanced practice nurses can handle 70 percent of what a primary care physician can offer. And many of us are linking our own healthcare plans to them.

Finally, let me say something about what I expect to see in healthcare in general—and that has to do with nurses. You’re going to see nursing become more important in healthcare. One way of holding down costs—not necessarily lowering costs but holding down costs—is to put together integrated healthcare teams and to use nurses, pharmacists, and physician assistants, for what they’re good at doing.

If you look at where our big costs are—chronic care management—that’s where you’re going to see nurses and physician assistants. You’re going to see a larger role for nursing in the whole prevention area and you’re going to see healthcare reorganize itself, even with the limitations determined by state politics. Is that going to reduce our risk? Is it really going to drive down costs in the long run? I do believe that we can’t sustain these growth numbers. Congress has to find the political will to do something. And consumers are going to have to have a bigger role.

Why hasn’t anyone been able to present to the American people the summary that you presented so succinctly?
Part of the problem is that every time you start talking about healthcare, starting in 1933, when Franklin Roosevelt tried to do it, someone yelled, ‘Socialized medicine!’ The only reason we got Social Security and Medicare and Medicaid is because someone figured out the private sector couldn’t do it. We’ve tried all the private-sector solutions. For low-income workers, you’ve got to have government subsidies. I believe you can have a private delivery system, but we’ve got an ideological problem about the expansion of government. I think government only ought to get involved when it’s in the public interest and there’s not a private alternative. So, I don’t think the solution is a single-payer system. I think we take a complex entity and we get the systems right.

If healthcare reform is successful, you will have a tremendous increase in demand for medical services and a fixed supply. How does that work itself out?
We watched it in Massachusetts. What happened is that Massachusetts had this huge spike where demand went up, and then it settled down. That’s why I’m talking about the role of nurses. Most of the healthcare demand was for primary care. Once they got over that hump, the system seemed to settle itself down. What we know now is if you don’t have insurance, you’re more likely to be sicker by the time you go to the hospital. That’s what’s costing us money now. People who don’t have insurance tend to be sicker and tend to go to the hospital or to the doctor too late. That’s when it costs us more. So we’re better off paying for the entry level and then organizing it in a way that’s less expensive.

How are we going to get the states to allow all nurses to do everything you say they will do? If you want to buy a basic insurance policy in one state, it’ll cost you $1,500 a year and in another, $4,500. How do we solve problems like that?
One of the things about healthcare reform was there were going to be some national plans so we could do some of that. We’ve given the states the power over scope of practice for professionals, but it’s as much of a problem for doctor specialists as it is for nursing specialists because the politics plays in where everybody wants to restrict everybody else, to spread the wealth, so to speak.

The good doctors’ offices that you go into now have nurses playing dramatic and important roles as part of the healthcare system. We need that across the board. Part of it is pressure on the system to deliver high-quality care with a more integrated model. I actually think we’re going to get that.

Should consumers be more involved?
[Employers] are moving towards more consumer driven-plans that make sure people have their own money at risk. What you have to be careful about is price sensitivity, particularly for low-income people. You don’t want to put in a co-payment or some kind of a deductible that prevents them from going to a primary care physician or an advanced practice nurse.

There’s no accountability here, because people consider it a benefit that’s simply given to them and they aren’t conscious about the relationship between benefits and their own salary structure.

The fact is that both the right and the left oppose healthcare reform. The left, represented by the unions, has negotiated these huge benefit structures where people don’t pay anything and they say that they took that instead of taking salary increases. They’re very reluctant.

If someone starts talking about taxing high-cost plans, that’s going to affect mostly unionized employees. Number one, I think people have to have their own money involved, and number two, people need to be made conscious about the way they use the healthcare system so they understand what the costs are.

ADDITIONAL COVERAGE FROM THE AUDIT COMMITTEE ISSUES CONFERENCE:

• Uncertainty Rules: The 2010 Audit Committee Agenda Roundtable
• The Top 10 Concerns of Today’s Audit Committees
• Arthur Levitt: The Real Governance Problem
• Harvey Pitt: Ten (or so) Golden Rules

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.

The result is a profile of the federal agency most visibly aligned with markets and risk—a story both inspiring and impressive but daunting in its implications for boards of directors and their companies. As Schapiro embarks on her second year in office, the SEC’s 29th chairman commands a laundry list of initiatives that include crucial legislative proposals, with proxy access prominent among them. Her challenge will be to convince Congress that the agency’s shift to a self-funding—and therefore independent platform—will help restore public confidence in its ability to be an effective market overseer. And, of course, in the process, to rebuild its battered reputation.

To make that happen, Schapiro, the four commissioners and the SEC’s staff of 3,700 will need to reorganize themselves to mend the weaknesses in infrastructure exposed by the financial crisis and the criminal wrongdoing of investment scammers such as Bernard Madoff. The agency started the new year off with a bang on “Super Wednesday,” January 13, 2010. During an open meeting that morning, the Commission voted 5-0 on two high-profile matters:

• Proposed a rule to prohibit broker-dealers from providing customers with unfiltered, or naked, access to an exchange or alternative trading system as well as other measures to reduce market access risks. It also approved a new Nasdaq rule that requires broker-dealers offering sponsored access to Nasdaq to establish certain controls over financial and regulatory risks.

• Published a concept release inviting comment on the current market structure for trading U.S.-listed equities, a move that sparked both commissioners and staff to be most vocal during the meeting in urging, encouraging and even courting public remarks.

Then, in an afternoon press conference that same day, the Commission:

• Unveiled what the SEC called the most sweeping reorganization in the Division of Enforcement since 1972, including the establishment of a new Office of Market Intelligence to analyze tips according to internally developed risk criteria to identify potential securities fraud.

• Announced a series of enhanced “whistle-blowing” measures, including three levels of cooperative agreements, to encourage individuals and companies to be more proactive in the agency’s investigations and enforcement actions.

The ramifications for public company boards of the reawakened and newly charged SEC are numerous, particularly in the areas of risk management, compensation, shareholder communications and director qualifications, among others. Yet, even though Bernie Madoff is in jail and the recession is officially over, there is still a great deal of angst, as U.S. public companies and their boards eye ever-changing global economic and market risks. As they witness the prospects of additional regula-tory burdens targeting boardrooms and C-suites, the reaction is not enthusiastic across the board. Depending with whom you speak, you might hear bravos and encomiums, or lukewarm acceptance mixed with outright consternation.

“We’re going in the wrong direction,” says James A. Unruh, founding partner of Alerion Capital Group, former chairman and CEO of Unisys and currently an outside director of CSG, Prudential Financial, Qwest Communications and Tenet Healthcare. “Let’s face it. As public companies, we have dropped the ball in terms of some risk management. This means boards have to be more diligent in their oversight and management of risk.” But, he says, this should not not occur at the demand of the government. Unruh cites  “say on pay” and chairman/CEO splits as examples of where regulatory reforms are singling out issues that might be best left to directors.

“Shareholders are not well-informed enough, despite the spate of recent Congressional and SEC proposals and rulings enhancing shareholder communications,” he said, echoing what others have said: “If the shareholders are unhappy, they should vote against directors or sell their stocks. We need boards that are more transparent, but the solution is not to allow shareholders to make all the decisions.”