SEC and Congress Put Spotlight on Executive Compensation Consultants

Many companies engage compensation consultants to make recommendations on appropriate executive compensation levels, to design and implement incentive plans, and to provide information on industry and peer group pay practices. The services offered by compensation consultants, however, are often not limited to recommending executive compensation plans or policies. Many compensation consultants are retained by management to provide a broad range of additional services, such as benefits administration, human resources consulting and actuarial services. The fees generated by these additional services may be more significant than the fees earned by the consultants for their executive compensation services. There is regulatory and congressional concern that the extent of the fees and provision of additional services by a compensation consultant may create the risk of a conflict of interest that may call into question the objectivity of the consultant’s advice on executive compensation.

The SEC and Congress have responded to this concern. The SEC has adopted proxy disclosure requirements for compensation consultants who perform additional non-compensation related services to the company in excess of $120,000. Release No. 33-9089. The House has passed legislation requiring the SEC to adopt independence standards for executive compensation consultants.

Effective February 28, 2010, the SEC rules provide that, if a compensation consultant was engaged by the board compensation committee to provide advice on executive compensation, and the consultant also provided additional services to the company in an amount in excess of $120,000, the company must disclose the aggregate fees for recommending the amount or form of executive compensation and the aggregate fees for such additional services. There must also be disclosure of whether the decision to engage the compensation consultant for those other non-compensation services was made or recommended by management, and whether the compensation committee or the board approved such other services. In this situation, the SEC believes that the receipt of fees for non-compensation related services presents a conflict of interest.

If the compensation committee has not engaged a compensation consultant, but management has engaged a compensation consultant to provide advice on executive compensation, and the consultant has provided additional services in an amount in excess of $120,000, then the company must disclose the aggregate fees for recommending the amount or form of executive compensation and the aggregate fees for any additional services provided by the compensation consultant. The SEC recognized that in this situation the board may not be relying on the consultant used by management, and, therefore, conflicts of interest may be less of a concern. However, when management has a compensation consultant and the board does not have its own consultant to help filter any advice provided by management’s consultant, reasoned the SEC, the concerns about board reliance on consultants that may have a conflict are sufficiently present to require this approach.

Fee and related disclosure are not required when the board and management have different consultants, even if management’s consultant provides additional non-executive compensation related services. When the board engages its own compensation consultant, reasoned the SEC, it mitigates concerns about potential conflicts of interest involving compensation consultants engaged by management.

Services involving only broad-based non-discriminatory plans or the provision of information, such as surveys, that are not customized for the company, or are customized based on parameters that are not developed by the consultant, are not treated as executive compensation consulting services for purposes of the compensation consultant disclosure rules. However, the exception would not be available if the compensation consultant provides advice or recommendations in connection with the information provided in the survey.

The Commission settled on a disclosure threshold of $120,000 because it believes that fees for other non-executive compensation consulting services below that threshold are less likely to raise potential conflicts of interest concerns. Also, the disclosure threshold should reduce the recordkeeping burden on companies. This threshold is similar to the disclosure threshold for transactions with related persons in Item 404 of Regulation S-K, which also deals with potential conflicts of interest on the part of related persons who have financial transactions or arrangements with the company.

The House Wall Street Reform and Consumer Protection Act, HR 4173, would give the compensation committee sole discretion to retain compensation consultants meeting independence standards to be promulgated by the SEC. The compensation committee would be directly responsible for the appointment, compensation and oversight of the compensation consultant. However, there is no requirement that the compensation committee implement or act consistently with the recommendations of the compensation consultant. In addition, the hiring of a compensation consultant would not affect the committee’s ability or obligation to exercise its own judgment in carrying out its duties.

In a major governance reform, the House bill would require public companies to have a compensation committee composed of independent directors. Similarly, compensation consultants must satisfy independence criteria established by the SEC. The SEC is allowed to exempt categories of public companies, taking into account the potential impact on smaller companies.

To be considered independent, a compensation committee member cannot accept any consulting, advisory, or other compensatory fee from the company and cannot be an affiliated person of the company or any of its subsidiaries. The SEC would be authorized to exempt a particular relationship with a compensation committee member from these independence standards.

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