Business historians are hailing the Wall Street Reform and Consumer Protection Act of 2010, a.k.a. Dodd-Frank, as a legislative landmark, and rightly so. Like the Sarbanes-Oxley Act before it, Dodd-Frank expanded government turf even further into the board’s domain.
But passage of this major law was only the beginning. Now rules will be arriving—reportedly 240 in all, including 95 from the Securities and Exchange Commission. Most of the 95 rules apply to the Wall Street side (i.e., brokers), but several affect corporate boards directly. Most of these are located in Title IX under “Investor Protections,” “Accountability and Executive Compensation” and “Strengthening Corporate Governance.”
The SEC is charged with creating some 95 new rules under Dodd-Frank.
Normally, the SEC sends out one rule at a time for comment. But this year the agency began by issuing a general appeal for comments on any and all aspects of the law. So far, the SEC has taken action on three provisions, and set deadlines on the remainder. (Click on “Implementation of Dodd-Frank” at sec.gov for the complete timeline.)
Comments have come from a variety of groups and individuals around the country and from Washington itself, namely D.C.’s “Golden Triangle” neighborhood, a 43-block territory that extends northwest from the White House. Zip codes beginning with “200” reach this “other Washington,” home to some 3,000 advocacy groups, registered lobbyists, professional services firms and associations (including NACD).
Whether from grass roots or the Golden Triangle, comments presage rules. So far, two governance topics have attracted the most comments—whistleblowing and compensation.
Bounties for Fraud Tips
The whistleblower provision of Dodd-Frank offers a bounty of at least 10 percent for a tip that leads to sanctions of $1 million or more. The tipster (who may be anonymous to the company) stands then to receive at least $100,000.
Professor Mike Koehler of Butler University wrote the SEC to say he worries about application to the Foreign Corrupt Practices Act (FCPA), a notoriously vague law. When directors and officers get sued under the FCPA they usually settle rather than litigate, since standards of proof are so amorphous.
In his letter, Koehler describes a race to destruction. “The whistleblower provisions may pit the whistleblower vs. the company in a strange, yet competitive, highstakes game of ‘who has the fastest car’ to Washington to disclose the conduct,” writes Koehler. “Simply put, if the whistleblower loses, the information he or she discloses will no longer be ‘original information’ and thus no award. If the company loses, the disclosure will no longer be ‘voluntary’ and the hoped-for credit under SEC policy guidelines, the DOJ’s Principles of Prosecution of Business Organizations and the Sentencing Guidelines will disappear.”
Koehler is not alone in his concerns. Charles Elson, a director of HealthSouth and the Edgar S. Woolard Jr. Chair in Corporate Governance at the University of Delaware, expressed concerns that the whistleblower provisions could eviscerate the compliance functions at companies. “Due process and loyalty aside, why would whistleblowers report apparent misconduct to a compliance officer when they could make a fortune and be heroes by going directly to the SEC?” Paula Cholmondeley, a director who serves on multiple boards, shares Elson’s concern. At a recent meeting of NACD New England, she predicted that companies will work proactively to motivate early internal reporting. (Note: One way to prevent whistleblower abuse would be for the SEC to pass a rule that penalizes tips that are frivolous or false—much as people get in trouble for calling 911 for no good reason.)
Compensation Provisions
Pay rivaled whistleblowing as a subject of comments. The most detailed comments to date have come from The Center on Executive Compensation, representing human resources officers at major companies. The Center offered 23 pages of comments in a letter signed by Senior Vice President and General Counsel Timothy J. Bartl. With respect to the advisory vote on whether say-on-pay votes should happen annually, biennially or triennially, he wrote that boards should have the flexibility to offer a vote on all three frequencies or an up-or-down vote on the alternative (e.g., one year) selected by management.
Another requirement of Dodd-Frank directs companies to disclose the amount of money paid to compensation consultants as a percentage of the consultants’ total revenues to ensure that they are independent.
Attorney Robert M. Fields comments that the law is “vague in setting forth the type of fees that will be taken into account making this assessment.” Fields writes: “Congress is only concerned with fees related to services other than those provided directly to compensation committees. Common sense would lead to this conclusion because…even if a law firm or compensation consultant has only one compensation committee client (and, accordingly, receives 100 percent of its fees from that client), it should clearly be deemed to be independent of the corporation itself because its services are provided only to that compensation committee.”
Fields draws a comparison to how director independence is spelled out in SEC Rule 16b-3 and the Treasury regulations promulgated under Section 162(m) of the Internal Revenue Code. “Both the rule and the Treasury regulations address the issue of whether a corporate director is independent, and both provide that one of the factors to be taken into account is the amount of compensation the director receives from the corporation other than fees paid to him or her in his or her capacity as a director.”
Similarly, Fields argues that the regulations stipulated by Dodd-Frank for the independence of compensation advisors should be specific. What percentage is allowed to be paid to a compensation consultant for services provided to a corporation versus a compensation committee? “Only those fees relating to services provided to a corporation other than fees related to services provided to the compensation committee” should be taken into account, argues Fields.
Compensation consulting firms Pay Governance (led by Ira Kay) and Frederick W. Cook & Co., have also sent valuable comments to the SEC on these matters.
Until the SEC clarifies ambiguities in Dodd-Frank, the following issues should be on compensation committee agendas, advised Peter Gleason, a managing director of NACD, while serving on a recent panel with several experts from Pearl Meyer & Partners:
- A strategy and timeline for say on pay and say on frequency
- Reaffirmation of the organization’s compensation philosophy
- An inventory of compensation practices and identification of “red flags”
- A re-appraisal of how annual and/or long-term performance metrics are selected
- Succession planning for the CEO and other key executives
- Potential shareholder outreach by the committee
Dodd-Frank contains many more provisions, such as mandated risk committees, worthy of comment. Members are invited to contact NACD for research support in this endeavor.