Wednesday, January 13, 2010

Executive Compensation Re-Regulation: Congress, the Federal Reserve, and the Securities and Exchange Commission

A team I have been working with just fed updates on a research document to some journals >> I scored a new section on executive compensation re-regulation! Each piece of re-regulation described below focuses on localized risk reducing initiatives in the name of the greater financial system.


The Corporate and Financial Institutional Compensation Fairness Act of 2009. Introduced by Representative Barney Frank (D-MA) in July, and out of Committee and the House Floor that same month. It is currently sitting in the Senate Committee on Banking, Housing, and Urban Affairs. (Most of the commentary I read suggested it would be dealt with there in the Fall of 2009, however …).

The bill amends the '34 Act to give shareholders a nonbinding advisory vote on all issues of executive compensation. Interesting trick here: institutional investment managers that cast such votes are required to publicly disclose how they voted – each year. There is also some discussion about compensation committee members – rules preventing conflicts of interest (so a prohibition on taking any sort of consulting or advisory fees from the issuer). Second interesting trick: the bill directs nearly a dozen federal regulators to formally convene and create new compensation and disclosure rules. One piece of construction guidance offered in the bill: individuals' specific income should not be disclosed. There you go, Tea Partiers. Here is the text of the bill.

The Federal Reserve ("Fed")

The Fed has issued Proposed Guidance on Sound Incentive Compensation Practices. I was deceived when I first opened the Federal Register; it sounded aspirational, at best. On the contrary – I counted the number of times the Fed threatened a poor supervisory rating or an enforcement action for failing to remedy a deficiency - twice - and the number of times the Fed directed immediate effort by banking organizations to come into compliance – three.

Every banking organization under the Fed's supervision is required to come into compliance with the guidance. The guidance is applicable to both executive employees and lower-level employees; it is more targeted towards any employee whose work responsibilities expose the employer bank organization – and again, the larger financial banking system as a whole – to risk. Interesting here: rather than establishing one rule for twenty different types of banking organizations, the guidance states several principles the Fed wants all of the banking organizations to come into compliance with; how any one bank abides by the principles is self-determined. The principles focus on managing the relationship between incentive compensation and employee risk-taking. Broadly, incentive packages should not encourage employees to risk-take beyond the employer banking organization's internal ability to identify, manage, and support that risk. As a means of collecting best practices (maybe a structural means of pushing compliance?), the Fed has created a scheme to supervise compliance. There are two tracks: one for large complex banking organizations ("LCBOs") and a second for smaller, less structurally complicated banking organizations. LCBOs are expected to offer a compensation plan to the Fed; smaller organizations will be assessed on compliance as a part of their annual risk examination process. You can read the text of the Fed's guidance in the Federal Register here.

The Securities and Exchange Commission ("SEC")

In an effort to better enable investors trying to identify the internal risk assumption and reward of a company, the SEC has adopted amendments regarding the disclosure of all employees' compensation. The new disclosure rules are effective February 28, 2010.

Companies are expected to disclose compensation practices that create the risk of a "reasonably likely" "material adverse" effect on the company. Companies are in fact to list situations occurring with their pay practices and among their employees that illustrate when a compensation practice does in fact create a "reasonably likely" risk of "material adverse" effect. (It appears there was a give-and-take during the comment period on the language.) Stef commentary on the effectiveness of the forthcoming disclosure: the list is explicitly non-exhaustive … The disclosure will be made in a new paragraph in Item 402 of Regulation S-K.

Also as regards company disclosure of stock and option grants in the Summary Compensation and Director Compensation Table – use the aggregate fair value grant date and footnote performance awards to disclose an award's maximum value.

(The SEC also voted to approve amendments: creating greater transparency for investors in determining conflicts of interest as regards compensation consultants; and a variety of disclosures regarding the board of directors, as regards nominee and director qualifications, the board's diversity, and the board's structural leadership.)

The final version of the SEC's amendments can be found here.

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