Companies are looking for more clarification on terms in the Security and Exchange Commission's proposal to make board members who serve on compensation committees more independent and to minimize conflicts of interest with compensation advisers.
The comment period on the proposal, which was released in March, ended last week. The SEC is leaving the details of the rule writing to U.S. stock exchanges, but many questions were left unanswered about what the rules might look like. For example, there are questions about whether compensation committees will have to hire separate legal advisers, as well as how “independent legal counsel” should be defined. At the deadline, 46 comment letters were sent to the SEC.
The comment letters from the business community centered on how terms would be defined in the final rule. For example, a May 12 letter from Pfizer's vice president and corporate secretary asks for a definition of “advice” in terms of compensation consultants' services, and it asks for the SEC leave director compensation out of the final rule.
Some of the comment letters also mention that there's not enough guidance in the proposed rules, since the rulemaking is almost Dodd-Frank recited verbatim, says James Reda, managing director of compensation consulting firm James F. Reda & Associates. “The only part of the rule that says something ‘must' be a certain way is the independence of the principle investor,” says Reda.
Some letters from business groups asked for less disclosure for how the compensation committee picks advisers. The National Association of Corporate Directors' Chairman, Barbara Franklin and President and Chief Executive Officer Kenneth Daly said in a letter from April 29: “The Commission should not adopt rule amendments to Regulation S-K to require listed issuers to describe the compensation committee's process for selecting compensation advisers pursuant to the new listing standards.”
Others are in favor of the provision. “The headline point for me is that they're considering not requiring disclosure of the process used to select the compensation advisers, which to me just seems an unfortunately narrow reading of the statutory language,” says Robert Jackson, a professor at Columbia Law School.
Since members of most compensation committees are already independent—for tax and securities law reasons—and already have the power and financial ability to hire independent advisers, these rules should have little practical impact on how public companies operate in this area, says James Barrall, head of the compensation practice at the law firm Latham & Watkins. “The biggest practical impact on most companies is that the rules are likely to require even more disclosure and longer and less readable compensation, discussion, and analysis,” he says. “Numerous comments persuasively argue that the rules should not require compensation, discussion, and analyses to describe a Compensation Committee's process for selecting advisers because such disclosure would not be meaningful or important to most shareholders, and the proposed requirement of disclosure of any compensation consultant conflicts of interest is enough.”
“While you might like to prognosticate that these [regulations] won't be in affect for this year, you can't bank on that being a certainty.”
—Steven Seelig,
Executive Compensation Counsel,
Towers Watson
The comments reveal that that the business competition between boutique executive compensation consulting firms and full-line firms that provide human resources, benefit plan consulting, insurance brokerage, and other services to public companies—in addition to executive compensation consulting—is “alive and well,” as the commentators debate the meaning of “independence” and the factors that should be taken into account in evaluating it, Barrall says.
Compensation advisers, especially the large firms that are targeted by the conflict-of-interest aspects of the rule, opposed some of the measures and asked the SEC to define “independence” more broadly. The rule would limit boards from using the same compensation adviser on executive pay that management used to advise on overall company compensation or benefit plans. In an April 29 comment letter, Towers Watson Managing Director Douglas Friske and Executive Compensation Counsel Steven Seelig said: “When engaging executive compensation advisers, compensation committees should take into account a range of factors that may have an influence on the adviser's objectivity and independence. Dodd-Frank identified at least five factors that compensation committees should consider. These go beyond a narrow focus on the extent of other services a consultant's firm provides, which is currently the sole issue addressed by the Commission's consulting fee disclosure requirement.”
CHAMBER OF COMMERCE SPEAKS OUT
Below is an excerpt from the Chamber of Commerce letter regarding the SEC's proposed rule on Listing Standards for Compensation Committees:
The U.S. Chamber of Commerce is the world's largest business federation, representing more than 3 million businesses and organizations of every size, sector, and region. The Chamber created the Center for Capital Markets Competitiveness to promote a modem and effective regulatory structure for capital markets to fully function in a 21st century economy. To achieve this objective it is an important priority of the CCMC to advance an effective and transparent corporate governance structure. The CCMC welcomes this opportunity to comment on the Proposed Rules on Listing Standards for Compensation Committees proposed by the U.S. Securities and Exchange Commission.
For the reasons stated below, the CCMC believes that a 23-day comment period is wholly inadequate for minimal standards to insure appropriate rulemaking. Accordingly we request that the SEC extend the comment period for the proposed rules from April 29, 2011, through June 5, 2011, to insure a 60-day comment period.
The proposed rule, adds Section 10C to the Securities Exchange Act of 1934, requiring the Commission to adopt rules directing the national securities exchanges and national securities associations to prohibit the listing of any equity security of an issuer that is not in compliance with Section 10C's compensation committee and compensation adviser requirements. The proposed rule also requires the Commission to adopt new disclosure rules concerning the use of compensation consultants and conflicts of interest. Interested parties are allowed 23 days from the proposed rule's April 6, 2011 publication in the Federal Register to provide comment, with a final due date of April 29, 2011.
The abbreviated 23-day period does not provide sufficient opportunity for the many companies, organizations, and other stakeholders that would be impacted by the listing and disclosure requirements to adequately assess and provide meaningful comments on the many significant and complex issues raised in the proposed rule. Moreover, the SEC has seven other proposed rules open for comment in which many of the same companies, organizations, and stakeholders impacted by changes in listing and disclosure requirements will be providing comment on one or more of the existing seven SEC Proposed Rules. Thus, additional time will be necessary to consider the full impact of all proposed listing and disclosure changes and provide thoughtful commentary.
We also note that six of the other proposed rules allow at least 45 days for comment. In an effort to maintain parity, and the reasons stated above, we respectfully request that the SEC extend the comment period on the proposed rule until June 5, 2011. While we recognize that each rulemaking is of different complexity and that there is not set standard for the length of a comment period, we believe that the SEC should recognize the scope of the rule and the breadth of rules that stakeholders must comment on at anyone time. Accordingly we believe in this case that a 23-day period is wholly inadequate and that it will be in the public interest to allow all interested parties at least 60 days to respond to this proposed rule.
Source: Comment Period Extension Request From Chamber of Commerce.
Boutiques firms, however, called for less discussion of those factors, instead highlighting times when “independence,” as defined in the rulemaking, might be too broad. For example, in a letter also from April 29, Frederic W. Cook & Co.'s Managing Director David Gordon said, “It is possible that future developments may indicate a need to revisit the issue of describing the selection process. At this time, however, we believe it more appropriate to monitor the impact of the new requirements in section 10C as they unfold over the next couple of years, before considering more disclosure requirements.”
“The main concerns for compliance officers are whether their independent executive compensation consultant is truly independent—outside of the typical definition of independence that focuses on whether any other work is done for the corporation,” said Jack Dolmat-Connell, president of compensation consulting firm DolmatConnell & Partners.
The relatively low number of comment letters may indicate a lack of interest in the proposals, even from companies and business groups, says Dolmat-Connell. “The thing that I found most surprising was the near complete lack of a corporate response in this arena, ergo most companies must not feel this is an important issue.”
The comment period was extended after the Chamber of Commerce complained that the short 60-day period was not enough time for business groups to express their views.
While the comment period was only extended by 20 days, it might be enough to push the effect of any resulting rules into next year, says Seelig. If they do go into effect this year, he says it could cause some problems for companies that have already hired a compensation adviser. “The question is, if you have a listing exchange requirement in place, but you haven't actually considered those factors in hiring your consultant, what do you do with that?” notes Seelig.
This has led some people to suggest that the regulations would need to be made available next year, although there's no way to know that in advance, Seelig says. “While you might like to prognosticate that these won't be in affect for this year, you can't bank on that being a certainty,” he says. “It's possible that the SEC could have a meeting on this by the end of May, after assimilating all the comments. It's possible. Then you vote to finalize, you run 90 days from then—It is possible to have this in effect by the end of the year.”
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