Dodd-Frank Wall Street Reform & Executive Compensation
July 2010
According to its introduction, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) signed into law by the President recently was created with the following intent:
to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end `too big to fail', to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.
The ambitious sweep of this “war-to-end-all-wars” sort of statement is not uncommon in major pieces of legislation. But based on historical precedent, we can be confident the Act will produce any number of unintended consequences and, although less likely, be pleasantly surprised if it succeeds in accomplishing even one of its stated objectives.
Presumably, the “other purposes” are executive compensation and governance provisions, which are referenced in only nine of the Act’s 200+ sections. Of those nine, two contain provisions that may in fact have a positive effect, whereas most of the remainder merely elaborate on requirements that already exist or have been superseded by trends and practices.
What follow are summaries and effective dates of the Act’s major executive pay and governance provisions with our italicized comments. If no date is indicated, the provision is effective upon publication of SEC rules.
Say-on-Pay. The highest-profile provision of the Act requires companies to give shareholders a non-binding vote at least every three years to “approve the compensation of executives” and every six years to approve whether compensation is approved every one, two or three years. Companies must also offer to shareholders a non-binding vote on any extra executive compensation related to a transaction: so-called golden parachute arrangements. The say-on-pay votes must take place beginning with annual shareholder meetings held on or after January 21, 2011.
This provision, along with the enhanced disclosure requirements around the relationship between executive pay and corporate performance (see below), may have the salutary effect of encouraging companies and their boards to think through more comprehensively than is often the case the relationship between pay and individual performance and between pay and corporate results. It may also encourage companies to put a higher priority on clearly explaining compensation policies to shareholders and to their executive teams(!). I mention the executive team because, while intentions are usually sound, executive pay programs are often so complex that the intended recipients—never mind shareholders—barely understand them.
Compensation Clawbacks. Included in the Act is a requirement that executives return to the company any paid compensation based on company results that are subsequently found to be erroneously reported.
Sarbanes-Oxley already requires clawbacks (albeit more limited than those contemplated by the Act).
Executive Pay at Financial Institutions. The Act requires enhanced regulatory reporting of executive pay policies at financial institutions. Effective after rules are published by 4/21/2011.
Financial institutions that accepted TARP money already have a special and somewhat restrictive compensation reporting and limitations regime.
Compensation Committee Independence. Members of Compensation Committees must all be independent and must consider a number of specified factors to determine the independence of potential legal and consulting advisers before choosing them. Effective July 21, 2011.
Existing exchange listing regulations and IRC requirements on the tax deductibility of executive pay in excess of $1 million (IRC Section 162(m)) have already led most Compensation Committees to be composed entirely of independent members.
Existing SEC rules already require disclosure of any significant compensation consultant relationship with management.
Pay-for-Performance. Enhanced disclosure is required of pay-for-performance policies, and companies must also disclose the ratio of the CEO’s pay over the median pay for all other employees.
While companies are already required to disclose the relationship between performance and pay in their proxies, the implications of this provision, which requires SEC rules to be effective, are for more structure—perhaps analytical in nature—around the communication to shareholders of the pay-for-performance relationship. Leaving aside what many will perceive as an unnecessary mandate, this provision, like the Say-on-Pay provision noted above, will have the beneficial result of encouraging companies to tighten up their thinking on how pay programs relate to company profitability and ultimately shareholder returns.
As for requiring disclosure of the relationship between CEO pay and the median corporate compensation, similar ratios have been used by executive-pay critics to demonstrate the excessiveness of CEO compensation, especially when comparing the U.S. to other developed countries. The impact of disclosing this ratio remains to be seen, but other than making it easier for these critics to gather data come proxy season, we anticipate it to be minimal.
Corporate Governance. Companies must disclose their reasoning as to why the CEO and Board Chair are, or are not, the same person and provide shareholders with proxy access to make Board nominations.
SEC guidelines on proxy disclosure already require discussion around the issue of whether or not the CEO and Board Chair roles are combined and what qualification criteria are used to select Board members. This provision simply further encourages companies to be more definitive in their explanation of why the proposed Board slate is best for the Company.
