White House to propose new rules on executive compensation

By Cydney Posner

The Obama administration intends to propose new rules that would allow shareholders and the SEC to exercise more oversight over executive compensation at all publicly traded companies . Linked is the statement from Treasury Secretary Geithner. Much of the proposal seems quite similar to that proposed by Senator Schumer. (See the postings on 5/15/09 and 6/01/09) Not to be outshined, SEC Chair Mary Schapiro is using this opportunity to issue a press release discussing the various compensation proposals she has described in prior interviews and speeches. (See the postings on 4/6/09 and 5/4/09) Rumor has it that the SEC's proposals will be introduced in July. Here is a Washington Post article regarding the new White House proposal and one from the WSJ (an article, not a proposal). The Post reports that draft legislation on the White House proposals is expected to be sent to Capitol Hill soon.

The White House proposal would provide for non-binding annual "say on pay" by shareholders regarding:

• executive compensation as disclosed in the proxy, including CD&A and the quantitative disclosure of amounts executives are entitled to receive,
• annual compensation for the top five named executive officers as disclosed in the company's proxy statement (unclear if this point is really distinct from above), and
• golden parachute compensation disclosed in proxy solicitation materials prepared for shareholder meetings relating to change-in-control transactions.

A second proposal would authorize the SEC to ensure that compensation committees at companies meet independence standards like those applicable under SOX to audit committees. including a prohibition on fees to committee members other than for board or committee service. Attorneys or consultants providing service to the committee must be engaged by and report to the committee rather than management, and the company will be required to provide funding for these outside advisors. In addition, the SEC will be required to establish standards for ensuring the independence of compensation consultants and outside counsel used by the compensation committee.

In his press release, Secretary Geithner stated that this "financial crisis had many significant causes, but executive compensation practices were a contributing factor. Incentives for short-term gains overwhelmed the checks and balances meant to mitigate against the risk of excess leverage." However, Geithner emphasized that the government is "not capping pay. We are not setting forth precise prescriptions for how companies should set compensation, which can often be counterproductive." Accordingly, he announced a set of broad-based principles to begin the "process of bringing compensation practices more tightly in line with the interests of shareholders and reinforcing the stability of firms and the financial system." These principles include:

• Compensation should be tied to performance in order to link the incentives of executives and other employees with long-term value creation by conditioning pay on a "wide range of internal and external metrics, not just stock price. Various measurements can be used to distinguish a firm's results relative to its peers, while taking into account the performance of an individual, a particular business unit and the firm at large."
• Compensation (at levels beyond executives) should be structured to account for the time horizon of risks. Compensation practices contributed to the crisis by allowing employees to "earn immediate gains without their compensation reflecting the long-term risks they were taking for their companies and their shareholders….Companies should seek to pay top executives in ways that are tightly aligned with the long-term value and soundness of the firm. Asking executives to hold stock for a longer period of time may be the most effective means of doing this, but directors and experts should have the flexibility to determine how best to align incentives in different settings and industries."
• Compensation practices should be aligned with sound risk management and should be designed to avoid unintentionally encouraging excessive risk-taking. Compensation committees should "conduct and publish risk assessments of pay packages to ensure that they do not encourage imprudent risk-taking" and make efforts to ensure that risk managers have the stature, tools and the authority necessary to impose a check on risk-taking activities.
• Golden parachutes and supplemental retirement packages should be reexamined to determine whether they really align the interests of executives and shareholders when a company is the potential target of an acquisition as originally intended or whether they instead reward top executives even if their shareholders lose value. "Often, they [parachutes] have been expanded beyond that purpose to provide severance packages that do not enhance the long-term value of the firm. Likewise, supplemental executive retirement benefits can make it more difficult for shareholders to readily ascertain the full amount of pay due a top executive upon leaving the firm."
• Transparency and accountability should be promoted in the process of setting compensation. "Many of the compensation practices that encouraged excessive risk-taking might have been more closely scrutinized if compensation committees had greater independence and shareholders had more clarity. In too many cases, compensation committees were not sufficiently independent of management, while companies were not fully transparent in explaining their compensation packages to shareholders." Disclosure should "make clear in a single place the total amount of 'walkaway' pay due a top executive, including severance, pensions, and deferred compensation."

The  say-on-pay fact sheet  can be found here. The  independent compensation committee fact sheet  can be found here.

In her press release, Chair Schapiro more formally indicates that the SEC is actively considering a package of new proxy disclosure rules that "would lead companies to analyze how compensation impacts risk taking and the implications for long term corporate health of the behavior they are incenting." These proposals include enhanced disclosure regarding:

• How a company — and its board — manages risks;
• A company's overall compensation approach, including whether there are incentive structures that rewarded short-term risk-taking without taking into account the potential long-term effects on the company;
• Potential conflicts of interest by compensation consultants, including disclosure of relationships between the consultants and the company and their affiliates;
• Director nominees, including their experience and qualifications to serve on the board or on particular board committees; and
• Why a board has chosen its particular leadership structure.