ON Securities : Securities Lawyer & Attorney for Corporate Governance & Executive Compensation Matters

On Friday, the House of Representatives passed the Corporate and Financial Institution Fairness Act of 2009. The Senate still needs to consider similar legislation, and any differences will need to be resolved.

For most public companies, the bill will (1) require an annual advisory vote on executive compensation ("Say-on-Pay") and (2) for exchange-traded companies, increase the independence requirements for compensation committee members. The bill also would, if enacted, regulate pay at the largest financial institutions. TheCorporateCounsel.net Blog in its August 3, 2009 post contains an excellent summary of the bill. As that blog points out, Say-on-Pay almost certainly will not be a reality during the 2010 proxy season.

The bill allows the SEC to exempt certain companies from both the Say-on-Pay requirement and the compensation committee requirements. Therefore, the SEC might exempt smaller companies from either or both provisions.

We have updated the ON Securities Cheat Sheet to include the revised status and content of this bill. As you can see, there are still several other bills making their way through the Senate and the House, as well as several proposed regulations that would impact governance and compensation. These bills and rules continue to jockey for position, like the toy arcade horses in the video that amuses me so much.

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Proposed Compensation Disclosure Amendments Affect Risk Disclosures and Summary Compensation Disclosure Table Values

Last Friday, the SEC issued its release that details the proposed amendments to the compensation disclosure requirements for public companies, which the SEC approved on July 1. If adopted, the changes would generally be effective for the 2010 proxy season. Two of the most important proposed changes:

CD&A. The SEC proposes to add a new instruction to the requirements for the Compensation Discussion and Analysis section of the proxy statement. A company would be required to disclose how its overall compensation policies for employees create incentives that can affect the company's risk level, and its management of risk. The disclosure is required if the compensation policies (including compensation of non-executives) create risks that may have a "material adverse effect" on the company. The new CD&A instruction includes a laundry list of situations that might require disclosure, such as the payment of bonuses based on short-term goals, in situations where the risk to the company extends over a longer period of time.

Comment: The examples in the instruction seem like they are lifted right out of the pre-meltdown playbooks of Lehman Brothers and other financial institutions - the bonus practices of these institutions clearly encouraged risky practices that brought down some of the institutions and nearly brought down the world economy. In other industries, it's hard to imagine that companies will come to the conclusion that their compensation practices create "material risks" for the company.




 




Assuming the SEC adopts the new instruction, I would guess that very few companies other than financial institutions will disclose anything but a generic sentence stating that the company has done the risk assessment and found nothing material. For the financial institutions that have accepted TARP funds, the American Recovery and Reinvestment Act of 2009 and the related Interim Treasury Regulations already require specific risk assessment in their compensation practices. For other companies, does the SEC really need to add two pages of instructions to CD&A, for such a limited result for most companies? My guess is that the Commission was responding to public pressure to do something about the risky behavior that led to the current economic mess.

 

Comment: This change reverses the last-minute change the SEC made in the SCT disclosures in December 2006, without public comment and just as the compensation disclosure rules were going into effect. The 2006 SEC release that implemented the "December surprise" stated the SEC's belief that "this disclosure ultimately will be easier for companies to prepare and investors to understand." In fact, the effect was just the opposite - the current amounts are difficult to calculate and confusing to investors, as each year's dollar amount includes a variety of equity awards that have been granted in different years and are amortized over time. As famously reported by Gretchen Morgenson of the New York Times, the current calculation method can actually lead to negative compensation numbers for some executives in some years. The new method, if it is adopted, will be more predictable and will relate more closely to the equity grants made in the year in question.

And that's not all. The proposed rules would make a number of other changes, which will be discussed in a future posting.What do you think of the proposed amendments? Post a comment below or send me an e-mail and let me know.

You Don't Have to Work at a Small Public Company to Enjoy These Podcasts!

Our June 24 program for the Small Public Company Forum is now available as a series of downloadable podcasts. The Forum program contains valuable insights from experienced professionals at several firms on:

• Detection of financial fraud, and Section 404 internal controls compliance.
• Raising money in the current economic environment.
• How to deal with underwater stock options (yes, this was my program with the singing fish!).

Unfortunately, the podcast does not come with the delightful breakfast hosted by the Forum sponsors. If you want to get notice of future programs, subscribe to RSS e-mail updates in the top gray box on the right side of the Forum website.

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The SEC takes action on July 1, but that's not the whole story.

On July 1, 2009, the SEC voted to take several actions:

The Commission proposed rules that would clarify the statutory requirement that TARP recipients hold annual stockholder votes on compensation ("Say-on-Pay").

The Commission proposed revisions to the compensation disclosure rules that, among other things, would (1) disclose the relationship to risk of a company's overall compensation policies (not just policies covering top executives) and (2) disclose potential conflicts of interest of compensation consultants.

In probably the most important move, the Commission approved the New York Stock Exchange's proposal to eliminate discretionary voting in elections of directors. Therefore, brokers must receive instructions from the beneficial owner before voting. The conventional wisdom is that brokers acting without instructions generally vote in favor of management's slate, and that this change will reduce the percentage of shares voting for the director candidates in routine elections. The Wachtell Lipton law firm presented an interesting analysis of this issue in March, taking the position that the current broker votes in favor of management are a pretty good proxy for the votes of retail stockholders, who generally support management's candidates.

However, to understand the impact of the July 1 actions, it is necessary to understand other current developments, some of which would have an even greater impact on a broader segment of companies:

The Commission's Say-on-Pay proposals covered only TARP recipient companies. However, the Shareholder Bill of Rights Act introduced in the Senate by Senator Schumer, if adopted, would mandate Say-on-Pay for all public companies, as would two other bills currently being considered by Congress.

The Commission did not require that public companies adopt a specific structure to assess risk and ensure that compensation practices are consistent with the company's risk profile. However, the ARRA and the Treasury's interim final rules currently require the compensation committees of TARP recipients to perform specific risk management functions. Also, the Schumer bill would require that the board of directors of all public companies form a risk committee of independent directors to report to the board about the company's risk profile and the appropriateness of its compensation practices.

The elimination of discretionary voting by brokers takes on added importance because it could alter the balance of power between management and activist stockholders, especially for companies that have adopted majority vote standards in director elections. This shift would compound the potential increase in power by institutional investors that would result from the Commission's controversial proxy access proposal, reported here, which would allow large stockholders to nominate director candidates who would be included in management's proxy statements.

The bottom line: you need a scorecard to keep everything in context. The ON Securities Blog is working on a scorecard that will cover the SEC proposals, the Schumer bill, other pending bills and the Treasury regulations under TARP and the stimulus bill. What would you like to see covered? Send me an e-mail and let me know.

Maslon Small Public Company Forum's Inaugural Event is a success (singing fish and all).

On June 24, 2009, I participated in the inaugural event of the Maslon Small Public Company Forum, which included presenters from Maslon, Baker Tilly Virchow Krause, Carver Moquist & O'Connor, Feltl and Company and Internal Control & Anti-Fraud Experts, LLC. Course materials and podcasts of the presentations are available at the Small Public Company Forum website, which we hope will be a great resource for small public companies across the region.

For my presentation on underwater options entitled "Underwaterworld", I presented the "world's leading expert on underwater options": Big Mouth Billy Bass, the famous singing fish. You can watch Billy's full performance here. In his immortal words, once you solve your company's underwater options problem, you can take his advice: "Don't Worry, Be Happy!"

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