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By David W. Herbst and Craig D. Miller
While the Dodd-Frank Wall Street Reform and Consumer Protection Act is largely directed at reforms within the financial services industry, Congress did not miss its opportunity to adopt regulations on corporate governance and compensation practices applicable to all public reporting companies. And that means private companies should consider whether or not voluntary compliance with some or all of the governance requirements contained in the Dodd-Frank Act may be appropriate for them as well.
Some of the act's most significant provisions, including those having to do with "Say on Pay," golden parachutes, clawbacks and proxy access, have already been amply discussed here and elsewhere. But other provisions have received less notice.
Chief among these is a statutory basis to require most listed public companies to have compensation committees comprised entirely of independent directors under standards that the Securities and Exchange Commission must adopt. The SEC is charged with identifying the factors for independence, but such factors must include the sources of all compensation paid to a director and any affiliation between the director and the public company.
In addition, the Dodd-Frank Act also provides the statutory basis to require that compensation committees of public companies be given the authority to hire compensation consultants, legal counsel and other advisers and to require that any compensation consultant, legal counsel or other advisor be independent under standards that the SEC must adopt. The SEC is charged with identifying the factors that affect the independence of such advisers, but such factors must include the scope of other services provided by the adviser to the public company, the amount of fees paid by the public company to the adviser relative to the adviser's total revenue, conflict-of-interest policies maintained by the adviser, business relationships between the adviser and any member of the compensation committee, and stock owned by the adviser in the public company.
In addition, the Dodd-Frank Act reinforces compensation-related disclosures already required by the SEC for most public companies and adds some additional layers of disclosure, including a requirement to disclose the median of the annual total compensation of all employees of a public company, excluding the compensation of the chief executive officer; the annual total compensation of the chief executive officer, and the ratio of the annual total compensation of all employees (other than the chief executive officer) to the chief executive officer's annual total compensation. The requirement to compare the chief executive officer's annual total compensation to the annual total compensation of all employees appears to serve little benefit in an analysis of the appropriateness of the chief executive officer's total compensation, but it does serve as a reminder that a compensation committee must be in a position to clearly articulate the reason and rationale for compensatory payments to the company's top executive officer.
Public companies should begin the process now of reviewing their compensation committee charters to ensure that their compensation committees are comprised only of independent directors and have the express authority to hire independent compensation consultants, legal counsel and other advisors. Compensation committees should promptly begin deliberations on whether they should immediately be retaining independent consultants and independent legal counsel in order to have at their disposal the resources necessary to ensure that their practices are consistent with the standards required by applicable law. This includes having appropriate procedures in place to properly administer their compensation programs and having the tools necessary to describe those programs to shareholders under enhanced disclosure requirements.
Although the provisions of the Dodd-Frank Act discussed above are applicable only to public companies, private companies should consider whether to adopt some or all of the governance and compensation-related practices to the extent practicable.
David W. Herbst and Craig D. Miller are partners in the law firm of Manatt, Phelps & Phillips.
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