Comments on SEC's Proposed Standards for Compensation Committees and Advisors

On March 30, 2011, the SEC issued proposed rules (PDF) under Section 952 of the Dodd-Frank Act, which added Section 10C under the Securities Exchange Act of 1934. The proposed rules will direct the national securities exchanges to adopt independence and other listing standards relating to compensation committees and compensation advisors. The proposed rules don’t contain any big surprises and probably won’t have a big impact on most companies’ practices, but there are still some provisions of interest.

Independence of Committee Members. Under new Rule 10C-1, the exchanges must adopt independence standards for members of compensation committees, considering factors such as the sources of compensation of the individual by the company, and the individual’s affiliations with the company. Note that exchanges such as the New York Stock Exchange and Nasdaq already require committee members to meet the exchanges’ general independence standards, and that at most companies the committee members also must meet additional independence standards such as the requirements for “non-employee directors” under Rule 16b-3.

Comment: Interestingly, the SEC did not specify the parameters of the independence standards. This is very different from Rule 10A-3, adopted under the Sarbanes-Oxley Act (SOX) to apply to audit committees. Rule 10A-3 specified the heightened independence standards for audit committees, rather than leaving the details up to the exchanges. In its new proposing release for Rule 10C-1, the SEC pointed out that the authorizing statutes had different language. Unlike the SOX provision, Section 952 of the Dodd-Frank Act did not require the SEC to establish the standards. However, there was speculation that the new rule would define standards for compensation committee members similar to the provisions of Rule 10A-3 for audit committee members. Instead, it’s possible that the exchanges will each adopt differing sets of standards under the rule. Once the SEC adopts its final rules, the exchanges will have up to a year to adopt their final standards.

Standards for Selection of Advisors. Under proposed Rule 10C-1, listed companies’ compensation committees will also be required to consider five independence factors when selecting advisors such as consultants or counsel. Note that these advisors will not be required to be independent, but the committee will have to consider the factors, which include whether the advisor provides other services to the company, whether the advisor has business or personal relationships with members of the committee, and whether the advisor’s firm has adopted policies to prevent conflicts of interest.

Comment: Some commentators have speculated that, in practice, these standards will lead lots of compensation committees to engage independent counsel, because they won’t want to document that they chose non-independent counsel. We’ll see – I’m not convinced that this will happen in practice. After the adoption of SOX in 2002, there was widespread speculation that many audit committees would hire independent counsel. After the storm blew over, very few committees adopted this practice.

New Disclosure Standard. Under the proposed rules, Item 407(e)(iii) of Regulation S-K would be modified to add some additional disclosures in the proxy statement about the role of compensation consultants to the committee and payments to the consultants for other services to the issuer.

Comment: The proposed revised disclosures will not be dramatically different from the Item 407(e)(iii) disclosures added by the SEC for the 2010 proxy season.

New ON Securities Cheat Sheet Describes Provisions of the Dodd-Frank Act

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (final text of the Act, 848-page PDF). As previously reported, the Act includes numerous governance and compensation provisions that will affect all public companies, as well as comprehensive reform of the nation’s financial system.

I have updated the ON Securities Cheat Sheet (PDF) to reflect the final provisions of the Dodd-Frank Act. The front page of the Cheat Sheet now includes a complete summary of the governance and compensation provisions of the Act. For each provision summarized, the Cheat Sheet provides the section number for reference to the full section.

The back page of the Cheat Sheet includes a summary of some other provisions of the Dodd-Frank Act that affect many public companies or otherwise have an impact on the securities laws, including a whistleblower “bounty” program and an exemption, effective immediately, for smaller issuers from the attestation report requirements under Section 404(b) of the Sarbanes-Oxley Act. The back page also summarizes the SEC’s previously proposed proxy access rules, as well as some of the important changes in the SEC compensation and corporate governance rules adopted in 2009.

An up-to-date version of the Cheat Sheet will always be available by clicking on the box at the right side of the ON Securities Blog home page. I’ll continue to update the document to reflect the waves of SEC rulemaking that we can expect over the next few months. If you have any suggestions for ways to make the Cheat Sheet more useful or for other resources that might be helpful, please post a comment below or send me an e-mail.

Over the next few weeks, I will be posting on the various new requirements of the Act and the steps public companies should be taking to prepare for the new requirements. 

Note: If you want to print out the pages of the Act that contain the governance and compensation provisions, print out pages 466-496 and 524-540 in the PDF file.



"Busted" - Don't Be Blindsided by the SEC's New Enforcement Posture

busted1I spoke this week at a Minnesota CLE Conference on the topic of how public companies can avoid liability for their disclosures. In preparing my remarks, it struck me that the SEC is "loaded for bear" in going after public companies and their officers with investigations and enforcement proceedings. The SEC has increased and reorganized its enforcement staff and is trying to raise its profile - really, an attempt to justify the agency's continued existence. Recent examples, just during July and August of 2009:

    A recent accounting fraud case against General Electric, where GE agreed to pay a $50 million fine.

    The SEC's $33 million settlement with Bank of America for failure to disclose the approval of Merrill Lynch bonus payments in the merger proxy statement. The District Court is considering rejecting the settlement as too lenient, which the SEC is disputing.

    The SEC's "clawback" action to recover $4 million in incentive compensation from the CEO of CSK Auto, reported here. It's not clear whether the SEC will be successful in this case. However, clearly, the SEC is trying to send a message to corporate officers that, if the officers are not vigilant to preventing accounting fraud and disclosure violations, their own compensation may be at risk.

This is all happening at a time when private lawsuits for securities fraud are getting more difficult for plaintiffs' attorneys to bring - a point of agreement for the plaintiffs' attorneys and defense attorneys on the panel. This does not mean company officials can relax, due to the increased scrutiny from the SEC and, probably, increased skepticism from judges and juries about public company practices. As I said in this prior post, this atmosphere should lead public companies to carefully consider their disclosure processes, including the disclosure controls and procedures required under SOX.

In other words, once again, "Don't Get Caught Cheating." Or, make sure you're not "BUSTED" by the SEC.

If you would like a copy of my PowerPoint presentation from this week, send me an e-mail. If you have any tips on disclosure procedures, or just want to weigh in on the SEC's newly found "mojo", post a comment below.

Have a great Labor Day weekend!

Watch Out For Those Claws!

The SEC's recent clawback action against Maynard Jenkins, the former CEO of auto supplier CSK Auto Corporation, has gotten more commentary than just about any other recent enforcement proceeding I can think of. The SEC is seeking reimbursement of $4 million in Jenkins' bonuses and profits from his stock sales during years when CSK's financial results were inflated by accounting fraud. What's getting all the attention? The SEC has not charged Jenkins individually with any wrongdoing. claws2

The SEC is seeking the clawback under Section 304(a) of the Sarbanes-Oxley Act of 2002, which allows recovery of incentive compensation following a financial restatement "as a result of misconduct." Section 304 doesn't specify that the misconduct be tied directly to the individual from whom the recovery is sought. However, the SEC, in its press release announcing the action, reported:

It is the first action seeking reimbursement under the SOX 'clawback' provision . . . from an individual who is not alleged to have otherwise violated the securities laws. . . . . 'Jenkins was captain of the ship and profited during the time that CSK was misleading investors about the company's financial health,' said Rosalind R. Tyson, Director of the SEC's Los Angeles Regional Office. 'The law requires Jenkins to return those proceeds to CSK.'

Much of the negative commentary accuses the SEC of overreaching, in a situation where it could not state an accounting fraud case directly against Jenkins. However, this case is an extreme one - Jenkins collected $4 million in bonuses and stock profits at a time when the company was committing massive accounting fraud. The COO, CFO, controller and another responsible officer were all indicted, and the latter two individuals have already pled guilty. Even if the SEC couldn't make a direct case against Jenkins for the fraud, this is the perfect test case for the extension of a Section 304 clawback beyond the responsible individuals to the "captain of the ship".

Regardless of the result in the case, the SEC has sent another signal that it is "loaded for bear" - as we reported in this post, the agency has a beefed-up enforcement staff and new energy. Regardless of the result in the Jenkins "no fault clawback" case, the SEC will be putting more heat on executives in the coming months.