Now that the Securities and Exchange Commission (the “SEC”) has issued final rules implementing the shareholder advisory voting provisions under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), it is a good time to consider how your company will allocate responsibilities between the board of directors, the compensation committee and management for complying with the shareholder voting requirements and related disclosures.
The listing rules for the New York Stock Exchange require that listed companies have a compensation committee composed entirely of independent directors, and a written charter that addresses the committee’s purposes and responsibilities. According to those rules, the compensation committee must, at a minimum, have the direct responsibility to:
- Review and approve the corporate goals and objectives relevant to chief executive officer (“CEO”) compensation, evaluate the CEO’s performance and, either as a committee or together with other independent directors, determine and approve the CEO’s compensation based on the committee’s evaluation
- Make recommendations to the board with respect to non-CEO executive officer regular, incentive and equity-based compensation
- Prepare a disclosure that the committee has reviewed and discussed with management the Compensation Discussion and Analysis (“CD&A) required by Item 402(b) of Regulation S–K and, based on that discussion, has recommended to the board that the CD&A be included in the company’s annual Form 10–K or proxy statement
- Conduct an annual self-evaluation of its performance
The listing rules also recommend that the charter address member qualifications, appointment and approval procedures, committee structure and operations, and committee reporting to the board. In addition, if the committee retains outside advisors, the listing rules state that the committee should have sole authority to retain or terminate its advisors and approve their fees or other retention terms.
This year, when conducting its annual self-evaluation, a compensation committee should consider:
- the increased responsibilities imposed on it by the Dodd-Frank Act;
- what additional resources the committee will need, and what committee structures and operations may need to be changed to fulfill those responsibilities; and
- what, if any, conforming changes to the charter should be recommended for approval by the board.
Shareholder Advisory Votes
The Dodd-Frank Act requires public companies to offer their shareholders an advisory vote on:
- The executive compensation of the company’s named executive officers (a “say-on-pay vote”)
- The frequency (annually, biannually or triennially) of the say-on-pay vote
- The golden parachute payments to be made to company officers in the event of a merger, acquisition, going private transaction or tender offer
In preparing to conduct these shareholder advisory votes, a company should determine if it will recommend to the shareholders how frequently the say-on-pay vote should be offered. After the vote, and taking into consideration the actual results of the shareholder vote on frequency, the company can decide the actual frequency that the company will offer a say-on-pay vote. The company should also consider if a vote on golden parachute payments will be provided to shareholders as part of the company’s annual disclosure, or not until an applicable transaction is actually before the shareholders for approval. These decisions can be made by the full board of the company. However, in view of the compensation committee’s required responsibilities with respect to executive compensation and the SEC’s new say-on-pay rules (discussed below), the board should consider delegating to the compensation committee at least the authority to make formal recommendations to the board on how the company should proceed. Most compensation committee charters that we have seen are currently silent on the role of the compensation committee in this process.
Final SEC Say-on-Pay Rules
The final SEC rules amend Rule 402(b) of the Securities Exchange Act of 1934 to require pubic companies to disclose in their CD&A:
- whether the company has considered the shareholders’ most current say-on-pay vote in determining its compensation policies and decisions; and
- if the vote was considered, how it was considered and what effect such consideration had on the committee’s compensation decisions and policies.
Because the compensation committee must have direct authority to review and recommend the CD&A to the board, and to approve the corporate goals and objectives for CEO compensation, the compensation committee will inherently be required to determine whether the results of the say-on-pay vote were material and, if so, disclose the compensation committee’s process for reviewing the say-on-pay vote and any effect the vote had on the compensation committee’s compensation policies and decisions. For that reason, in most cases it would be a best practice for the board to delegate to its compensation committee the authority to make recommendations to the board about the usefulness of the say-on-pay vote and how frequently it should be offered to shareholders.
Additional Changes on the Horizon
Independence of Committee Members
As discussed above, members of the compensation committee of a public company must be independent directors. The Dodd-Frank Act requires the SEC to issue rules requiring the national securities exchanges to prohibit listing of the equity securities of any company that does not have a compensation committee consisting solely of independent directors. In addition, the standard of independence in the SEC’s rules will most likely cause the securities exchanges to issue more demanding standards of independence. The SEC has stated that it will issue proposed rules regarding these independence standards later this year. Because these rules may require changes to the committee members’ qualification standards in its charter, they should be monitored closely.
Independence of Outside Advisors
With the increasing burdens placed on compensation committees, the committees will probably need to increasingly rely on outside advisors. The Dodd-Frank Act requires compensation committees to consider competitively neutral standards in selecting its compensation consultants, legal counsel or other advisors. Compensation committees will need to be directly responsible for oversight of the advisors it retains, and public companies are required to provide funding for the reasonable compensation of the advisors the committee retains to assist it in appropriately performing its duties. The SEC has stated that it will issue proposed rules on adviser independence this year. Therefore, compensation committees need to put in place procedures for tracking fees paid to company advisors, and the relationship those advisors have to the company and its affiliates. When the SEC rules are issued later this year, a committee’s charter should be updated to incorporate these independence requirements for its advisors and the company’s obligation to pay reasonable compensation for those advisors.