Moving into May and the peak of annual meeting season, executive compensation is one of the top stories in the business media. To date, eight companies have failed their annual say-on-pay votes. With the bulk of annual shareholder meetings in the coming months, this number is expected to increase. This week, an editorial in the New York Times criticized the Securities and Exchange Commission (SEC) for failing to issue rules on another area of executive compensation—pay ratios—claiming the “main problem seems to be foot-dragging in the face of objections from corporate lobbyists.”
The article correctly identifies several factors. The SEC did delay issuing final rules on the CEO pay ratio until the second half of 2012, effectively postponing corporate disclosure of the ratio of chief executive pay to the company’s median salary until the 2013 proxy season. Also, a substantial number of comment letters have already been submitted to the SEC on matters regarding executive compensation disclosures, including some for which there are no rules pending. Lastly, the rules mandated for pay ratios in Dodd-Frank are unlike most other provisions in the legislation, in that Congress did not allow for much flexibility in crafting the final rules.
However, the NYT editorial did not mention several factors that have hindered progress for the SEC. According to the May 2012 Dodd-Frank Progress Report from Davis Polk, of the SEC’s 95 required rulemakings, the agency has missed the deadline for 56. When final rules are actually released, they are often met with criticism and lawsuits. Last summer the U.S. District Court of Appeals overturned the SEC’s proxy access rule on the basis that the agency had not conducted a thorough cost-benefit analysis. The SEC subsequently introduced a more robust economic analysis in its rulemaking process, leading to a missed deadline for releasing a final rule regarding the conflict minerals provision—which will require companies to track and disclose their use of minerals potentially sourced from the Democratic Republic of the Congo.
With the rigid mandates on the pay-ratio disclosure, the SEC is facing difficulties with one area not clearly defined: computing median compensation. While Dodd-Frank was explicit in the calculation of the ratio, it was not clear in how the median total compensation would be measured. This measurement leads to several questions: Does the compensation of every employee at an organization need to be computed? Should part-time employees be included in the calculation? Would international employees be included? If so, what foreign exchange rate would be used? Taking these questions into consideration, last August the AFL-CIO proposed the use of statistical sampling to calculate the median compensation, an option the SEC is taking seriously.
The argument is no longer whether pay ratio disclosures will have the intended effect of changing executive compensation. Instead, it is when and how these rules will be issued.
The landmark Dodd-Frank Wall Street Reform and Consumer Protection Act arrived into the world on July 21, 2010. Hailed as the new model for our economic system, it contained many new changes for corporate boardrooms. These changes were long sought by the shareholder community. Although this new law is still in its infancy, I can’t help but think that some of its corporate governance provisions are already in critical condition.
The Act’s prognosis was good; the bill had a strong supporter in the SEC and two branches of the Federal government backing its provisions. But, as always, things change. Within weeks, the U.S. Chamber of Commerce filed a lawsuit challenging proxy access. Then in November, the Republicans won control of the House of Representatives for the next two years. And finally, the SEC recently announced that they will not be able to fund the whistleblower office, thus hindering the rule. These three incidents amount to a broadside against the Act and could potentially halt its implementation in Corporate America.
On the other hand, the Act is not completely dead. Though the law has strong forces acting against it, all are in flux. The Chamber’s legal challenge is no guarantee and may likely fail in the courts. The House Republicans have made it clear that they plan to attack the Dodd-Frank Act but they have only promised “a significant amount of oversight.” Their attention will mostly be directed at minimizing the health care law. Additionally, amendments and any legislative changes to the bill will almost certainly face Senate rejection and/or a veto by President Obama. As for the SEC, their budget shortfall may only be temporary, and responsibilities for the whistleblower’s office will be carried out by the current SEC staff.
Will some provisions of Dodd-Frank ultimately meet their doom? Short answer: maybe. Two of the most important provisions of the Act—proxy access and whistleblower protections—are in question, but others, such as say-on-pay, will be in place for 2011. Sadly, the lack of certainty on some provisions will directly affect the governance of our public companies and the director community.
Corporate directors cannot relax as they wait and see what provisions will actually become reality. Even if some of these provisions ultimately fail, shareholders will surely not give up on them. Shareholders will still pursue proxy access and the SEC will surely concoct new disclosures for your board to prepare. The only option a board has is to prepare. Preparation means speaking with large shareholders, examining board composition, and reviewing executive compensation structures.
As we wait for the SEC to implement more key provisions of Dodd-Frank, many factors are at play. Whether the provisions thrive or their plugs get pulled, the coming year promises much drama.
The panel was composed of the experienced and knowledgeable co-chairs of the Report: Dennis Beresford, director of Fannie Mae, Legg Mason, Kimberly-Clark, and NACD; and Michele Hooper, director of UnitedHealth Group, AstraZeneca, Warner Music Group, PPG Industries, and NACD.
The regulatory environment has dramatically changed for the audit committee, since the Report was last updated in 2004. In response, NACD commissioned a rewrite of the Report, which is already a top seller. According to Mary Pat McCarthy, “clearly, [this] one report will benefit all.”
Beresford stressed that while the Report is not a “guide to audit committees,” it provides invaluable guidance on leading issues, such as: the audit committee’s responsibility in risk oversight, the relationship between the audit committee and the internal and external auditors, and setting the agenda.