The House passed the Corporate and Financial Institution Compensation Fairness Act, which would significantly impact the compensation practices for U.S. public companies and financial institutions. Representative Barney Frank's House Committee on Financial Services, which originated the Act, states that it responds to "the broad consensus among economic analysts and regulators that flawed compensation systems have provided excessive risk." We covered this topic briefly in our July 2009 Corporate Alert (click here).
This Act now goes before the U.S. Senate. If enacted, it would give federal regulators (the SEC, OCC and others) significant powers to (1) prohibit "perverse" compensation arrangements provided by financial institutions and (2) change the way public companies develop and implement compensation arrangements.
1. Compensation Plan Limits
The Act authorizes the SEC and other federal regulators to prohibit financial industry executive compensation arrangements they deem too risky.
The regulations may focus on high-water mark and clawback provisions, vesting criteria, profit measurement metrics, and compensation for performance by institutional profit centers engaging in investment strategies that the federal regulators deem unreasonably risky. However, the regulations cannot require a clawback of incentive compensation plans with a term not longer than two years that are in effect when the Act becomes law.
Fund managers may find this Act disconcerting should the regulations limit traditional performance-based compensation structures, which many consider to properly align fund manager compensation with investment performance. It is interesting to note that federal regulators have long held authority over certain executive compensation issues. For example, the SEC has promulgated regulations permitting certain types of performance based compensation otherwise prohibited under the Investment Advisers Act.
2. An Empowered Compensation Committee
Taking a cue from the Sarbanes Oxley Act's approach to audit committees, the Act will require public companies to have a compensation committee whose members are independent—generally, no commercial relationship with the company other than serving as one of its directors or board committee members. The compensation committee will have the power and authority to:
SEC regulations will develop the "independence standards" for the compensation consultants and counsel. In addition, the SEC proxy rules will require the public company to disclose if it used an independent compensation consultant. Failure to comply with these provisions may result in the SEC delisting the public company and may expose the board members to actions alleging a breach of their fiduciary duties.
The Act provides for:
The "say-on-pay" measures are more extensive than current Internal Revenue Code provisions that require stockholder approval for companies to deduct certain executive incentive compensation or to obtain tax-advantaged treatment for incentive stock options. This Act will now put the actual amount, vesting criteria, clawback and other terms of these awards in the spotlight.
Some stockholder activists have long asserted that "say-on-pay" measures would "shame" corporate boards into proper action on executive compensation and may foreshadow stockholder sentiment on director elections. "Say-on-pay" votes may be cumbersome. Directors might over-consider shareholder sentiment in determining executive compensation and, notwithstanding the Act's express language that it will not "create or imply any additional fiduciary duty" (emphasis added), board and committee members may have additional litigation risk and corporations may find their proxy season and D&O insurance more expensive.
For more information on the topics covered in this alert, please contact Rick Morris at (212) 592-1432 or email@example.com or Irwin Kishner at (212) 592-1435 or firstname.lastname@example.org. For information on related topics or on how Herrick can help you, please contact any of our employee benefits and executive compensation professionals listed here.
Copyright © 2009 Herrick, Feinstein LLP. Compensation Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.