By James Hamilton, J.D., LL.M.
The Senate Banking Committee has reported out financial reform legislation that would enhance corporate governance and mandate increased transparency of executive compensation. The bill gives shareholders a say on pay with the right to a non-binding vote on executive compensation. This advisory vote on executive compensation is designed to give shareholders a powerful opportunity to hold accountable executives of the companies they own, and a chance to disapprove where they see the kind of misguided incentive schemes that threatened individual companies and, in turn, the broader economy.
The bill provides that the shareholder advisory vote on executive pay will not overrule a decision by the company or the board, or create or imply any change to, or addition to, the fiduciary duties of the directors, or restrict the ability of shareholders to make inclusion in proxy materials related to executive compensation.
The bill also authorizes, but does not require, the SEC to grant shareholders proxy access to nominate directors. It does require directors to win by a majority vote in uncontested elections, which should help shift management’s focus from short-term profits to long-term growth and stability
Most public companies currently elect directors using the plurality standard, by which shareowners may vote for, but not against, a nominee. If shareowners oppose a particular nominee, they may only withhold their votes. As a consequence, a nominee only needs one “for” vote to be elected and unseating a director is virtually impossible. Plurality voting in uncontested situations results in “rubber stamp” elections. Majority voting ensures that shareowners’ votes count and makes directors more accountable to shareowners.
Thus, the bill requires the SEC to adopt rules providing that in an uncontested election a director receiving a majority of the votes cast must be deemed to be elected. If a director fails to win a majority of the vote in an uncontested election, the director must tender his or her resignation to the board. Upon accepting the director’s resignation, the board must set a date on which the resignation will take effect in a reasonable period of time and publish such date within a reasonable period of time as established by SEC rule. If the board declines to accept the resignation, the board must disclose the specific reasons why it decided not to accept the resignation and why that decision was in the best interest of the company and its shareholders.
The Commission is authorized to exempt a company from any or all of these requirements based on the company’s size, its market capitalization, the number of shareholders of record, or any other criteria, as the Commission deems necessary and appropriate in the public interest or for the protection of investors.
It is widely acknowledged that a sound corporate governance practice is to bifurcate the roles of board chairman and CEO. Thus, the draft would direct the SEC to adopt rules requiring a company to disclose in the annual proxy sent to investors the reasons why it has chosen the same person to serve as chairman of the board of directors and chief executive officer or why it has chosen different individuals to serve as board chair and chief executive officer.
In a major corporate governance improvement, the draft mandates independent board compensation committees. The SEC must adopt rules requiring for exchange listing that compensation committees include only independent directors and have authority to hire compensation consultants. This provision is designed to strengthen their independence from the executives they are rewarding or punishing. In determining the independence of compensation committee members, SEC rules must require exchanges to consider the source of compensation and any affiliation with the company or any of its subsidiaries.
SEC rules must also allow an exchange to exempt a particular relationship from the independence requirements, taking into consideration the size of an issuer and any other relevant factors.
The compensation committee has sole discretion to hire and obtain the advice of a compensation consultant and is directly responsible for the compensation and oversight of the work of the consultant. However, the compensation committee cannot be required to implement or even act consistently with the advice or recommendations of the compensation consultant. At the end of the day, nothing can affect the ability or the obligation of a compensation committee to exercise its own judgment in the fulfillment of its duties.
Further, proxy or consent solicitation materials for an annual or special meeting of shareholders must disclose if the compensation committee retained or obtained the advice of a compensation consultant; and whether the work of the compensation committee has raised any conflict of interest and, if so, the nature of the conflict and how it is being addressed.
The legislation directs companies to provide appropriate funding, as determined by the compensation committee, for the payment of reasonable compensation to a compensation consultant; and to independent legal counsel or any other adviser to the committee
The bill would require public companies to set policies to claw back executive compensation if it was based on inaccurate financial statements that don’t comply with accounting standards. The measure also directs the SEC to clarify disclosures relating to compensation, including requiring companies to provide charts that compare their executive compensation with stock performance over a five-year period.
The SEC is also directed to adopt rules requiring a company to disclose whether any employee or director is permitted to purchase financial instruments, including derivatives such as equity swaps, that are designed to hedge or offset any decrease in the market value of equity securities granted to the employee or director by the company as part of the compensation of the employee or directors or held directly or indirectly by the employee or director.
The Managers Amendment to the bill requires the SEC to amend Item 402 of Regulation S-K to mandate disclosure of the median of the annual total compensation of all employees, except the CEO; the annual total compensation of the CEO; and the ratio . The annual total compensation of an employee must be determined by reference to Item 402 of Regulation S-K. This disclosure is required in annual reports and proxy statements, among other filings.
The Managers Amendment also mandates that exchange rules must prohibit members that are not beneficial owners of a security from granting a proxy to vote the security in connection with a shareholder vote for the election of directors, executive compensation, or any other significant matter as the SEC may determine by rule, unless the beneficial owner of the security has instructed the member to vote the proxy in accordance with the voting instructions of the beneficial owner.
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