House Committee Will Mark Up Corporate Governance Legislation with Say-on-Pay Mandate

The House Financial Services Committee plans to mark up legislation mandating shareholder advisory votes on executive compensation as part of the overall reform of financial regulation. The legislation builds on the SEC’s executive pay disclosure rules to require that public companies include in their annual proxy to investors the opportunity to vote on the company's executive pay plans. The Corporate and Financial Institution Compensation Fairness Act would also require independent board compensation committees and independent compensation consultants. The legislation further requires all financial institutions, including brokers, dealers and investment advisers, to disclose compensation structures that include any incentive based elements. The measure also requires federal financial regulators to proscribe inappropriate or imprudently risky compensation practices as part of solvency regulation.

The measure would not set any limits on pay, but will ensure that shareholders have a non-binding and advisory vote on their company's executive pay practices without micromanaging the company. Knowing that they will be subject to some collective shareholder action should give boards pause before approving a questionable compensation plan. The legislation also contains a separate advisory vote if a company gives a new, not yet disclosed, golden parachute while simultaneously negotiating to buy or sell a company.

The non-binding advisory vote approach has been used in the United Kingdom since 2003; and is now used in Australia as well. The policy change is credited with improving management-shareholder dialogue on executive compensation matters and increasing the use of long-term performance targets in incentive compensation.

The draft legislation comes against the backdrop of a growing global consensus that executive compensation must be reformed because it favors excessive risk taking and contributed to the financial crisis. President Obama and the G-20 leaders pledged to pass legislation reforming the financial regulatory system. As part of that legislation, the leaders called for the comprehensive reform of executive compensation to base pay on performance not on excessive risk taking.

According to the G-20, regulations must ensure that compensation structures are consistent with firms’ long-term goals and prudent risk taking.

Specifically, the say-on-pay provisions of the House legislation direct the SEC to adopt rules, within one year, requiring that proxies for annual meetings provide for a shareholder advisory vote on the compensation of executives. Similarly, a proxy involving a merger, acquisition or sale of the company must provide for a shareholder advisory vote on any golden parachute agreements. The proxy must disclose the aggregate total of compensation to be paid pursuant to the golden parachute agreement.

The legislation also adds a new Section 10B to the Exchange Act mandating that listed companies have independent compensation committees. The SEC would be authorized to exempt smaller reporting companies from the mandate.

In order to be considered independent, a compensation committee member may not 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.

The legislation gives 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 work of the compensation consultant. However, there is no requirement that the compensation committee implement or act consistently with the advice or 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.

A year after enactment, companies must disclose in their annual proxies if the compensation committee retained an independent compensation consultant and, if it did not do so, explain why retaining such a consultant was not in the interests of company shareholders.

The compensation committee would also be authorized to retain independent counsel and other advisers meeting SEC independence standards. As with compensation consultants, the compensation committee would be directly responsible for the appointment, compensation, and oversight of the work of such independent counsel and other advisers. But the compensation committee would not be required to implement or act consistently with the advice or recommendations of such independent counsel and other advisers, and the retention would in no way affect the committee’s ability or obligation to exercise its own judgment.

The legislation orders companies to provide funding, as determined by the compensation committee, to pay compensation consultants and independent counsel and advisers hired by the committee.

The SEC is directed to conduct a study of the use of compensation consultants hired under this Act and submit a report to Congress within two years.

Finally, the legislation directs federal financial regulators, including the SEC and Fed, to jointly prescribe regulations to require banks, brokers and investment advisers to disclose the structures of the incentive-based compensation arrangements for officers and employees of such institution sufficient to determine whether the compensation structure properly measures and rewards performance; is structured to account for the time horizon of risks; is aligned with sound risk management; and meets other criteria as the agencies may determine to be appropriate to reduce unreasonable incentives for officers and employees to take undue risks that could have serious adverse effects.


The federal financial regulators mist also jointly prescribe regulations prohibiting compensation structures or bonuses or other incentive-based payment arrangements that encourage inappropriate risks that could have serious adverse effects on economic conditions or financial stability; or could threaten the safety and soundness of the financial institution.

The provisions of this section would be enforced under section 505 of the Gramm-Leach-Bliley Act, which provides for the strong enforcement of GLB’s privacy provisions. Section 505 provides that each functional regulator will enforce the provisions of GLB for the entities they regulate. Thus, by analogy, under the draft legislation, the SEC will enforce the provisions against brokers, dealers, and investment advisers. The SEC and other regulators are also authorized to use the full range of their enforcement powers in case of violations of the draft provisions.

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