Treasury Announces Two Executive Compensation Bills
Yesterday, Treasury announced that it has drafted two different pieces of executive compensation legislation – one related to say-on-pay and the other regarding compensation committee independence – that they’ve sent to Congress as part of the “Investor Protection Act of 2009.”
Compensation committee independence:
- Compensation committee members would be subject to the same additional independence standards as audit committees members under Rule 10A-3 (no consulting or advisory fees and cannot be an affiliate).
- Compensation consultants, legal counsel and other advisors to the committee shall meet independence standards to be promulgated by the SEC.
- The compensation committee has the authority to retain independent consultants and is directly responsible for their appointment, compensation and oversight (copied from the audit committee oversight of auditors).
- Proxy statements must disclose whether the compensation committee has retained an independent consultant, and if not, why not.
- The compensation committee has the authority to retain legal counsel and is directly responsible for their appointment, compensation and oversight (copied from the audit committee oversight of auditors). There is no requirement that proxy disclosure be made as to whether the committee retained such legal counsel.
- Companies must provide funding for the hiring of independent consultants and legal counsel by the committee.
- The SEC is required to study the use of compensation consultants and report to Congress in two years.
Broc tells us that these provisions are based on standards for independence of audit committees under Rule 10A-3. Rule 10A-3 implemented the requirements of Section 301 of the Sarbanes-Oxley Act of 2002 (Section 10A(m)(1) of the Securities Exchange Act of 1934.) As much as I wholeheartedly agree with these provisions in principle, I am skeptical about how well they will be implemented and enforced. Let’s look at how well the independence provisions that were implemented for Audit Committees in 2003 worked out. What did lawmakers hope to accomplish when the audit committee independence provisions were included in the Sarbanes Oxley Act?
According to the SEC:
“Accurate and reliable financial reporting lies at the heart of our disclosure-based system for securities regulation, and is critical to the integrity of the U.S. securities markets. Investors need accurate and reliable financial information to make informed investment decisions. Investor confidence in the reliability of corporate financial information is fundamental to the liquidity and vibrancy of our markets.
Effective oversight of the financial reporting process is fundamental to preserving the integrity of our markets. The board of directors, elected by and accountable to shareholders, is the focal point of the corporate governance system. The audit committee, composed of members of the board of directors, plays a critical role in providing oversight over and serving as a check and balance on a company’s financial reporting system. The audit committee provides independent review and oversight of a company’s financial reporting processes, internal controls and independent auditors. It provides a forum separate from management in which auditors and other interested parties can candidly discuss concerns…Recent events involving alleged misdeeds by corporate executives and independent auditors have damaged investor confidence in the financial markets.They have highlighted the need for strong, competent and vigilant audit committees with real authority. In response to the threat to the U.S. financial markets posed by these events, Congress passed, and the President signed into law on July 30, 2002, the Sarbanes-Oxley Act.”
“Recent events involving alleged misdeeds by corporate executives and independent auditors have damaged investor confidence in the financial markets.”
In the case of Compensation Committees, recent events involving “excessive pay” practices by companies that eventually failed or were taken over by the government and which continued even after those companies received taxpayer money in a bailout have “highlighted the need for a strong, competent, vigilant, [independent compensation committee] with real authority.”
Back in mid-2008, a coalition of 21 institutional investors lead by Connecticut Treasurer Denise Nappier, sent a letter to the Security and Exchange Commission (SEC). The letter to SEC Chairman Christopher Cox reads in part:
“We believe a potential conflict of interest exists at companies in which consultants are hired to do work for both a company’s management and its compensation committee. When a consultant performs such services as benefits management on the one hand and advises the board’s compensation committee on executive pay matters on the other hand, we believe that the consultant’s integrity may be jeopardized.”
Some of us have been talking about this from the beginning.
I think there was no question immediately prior to Sarbanes-Oxley that partners from a company’s audit firm could not also be Directors or sit on the Audit Committee, although that was not so unusual in the not so distant past. Sarbanes Oxley did make it clearer that senior members of the audit team could not join a client company directly and that the audit partner, but not the firm itself, must be rotated every five years so as not to get too comfortable with each other. But I wrote about a pretty egregious violation, in my opinion, of that rule here. As far as I know, nothing was done about it.
The provisions to make sure members of the Compensation Committee are not also consulting to the company (general independence) and that they have direct, rather than via a company executive, authority for appointing any compensation consultants are pretty basic. I do not see in the Treasury Fact Sheet any discussion of a provision that explicitly requires compensation committees to hire truly independent compensation consultants, ones that do not have the conflict mentioned above as a result of also working for management or potentially being the same firm that is the auditor.
“The compensation committee will be directly responsible for the appointment, compensation, retention and oversight of the work of any compensation consultants that it retains, and these compensation consultants must report directly to the compensation committee…The new requirements will direct the SEC to establish standards for ensuring the independence of compensation consultants and outside counsel used by the compensation committee. “
Those rules are still coming.
Actual Audit Committees did experience significant change post-Sarbanes-Oxley as the rules were adopted and made part of Audit Committee Charters, proxy standard language, and annual disclosures. One of the most important results of Sarbanes-Oxley is improved corporate governance disclosures, such as more extensive biographies/disclosures regarding Board members, including other board memberships. They now include designation of “financial experts” required by each Audit Committee, detailed descriptions of the policy and process of each committee of the Board, and charts or at least description in each biography of Committee membership and chairmanships.
Based on this new and improved disclosure, I looked at one interesting company, GM, its Audit Committee members, and whether or not, in my opinion, the Audit Committee independence requirements really changed the end result. Did this “new and improved” independent Audit Committee, in the words of the SEC,
- Play a critical role in providing oversight over and serving as a check and balance on the company’s financial reporting system?
- Provide independent review and oversight of a company’s financial reporting processes, internal controls and independent auditors?
- Provide a forum separate from management in which auditors and other interested parties can candidly discuss concerns?
- A “going concern opinion” on March 5, 2009, finally, that was written off by pundits with minimal knowledge of its true power and purpose, as meaningless. Sad but true. “A “going concern” annotation for GM may make good headlines, but it does not mean a thing.”
- An “unthinkable” but inevitable bankruptcy filing on June 1, 2009, three months after the “going concern” opinion.
- The bailout and then the executive pay controversy.
GM Audit Committee as of December 31, 2008
“Our Board of Directors has a standing Audit Committee to assist the Board in fulfilling its oversight responsibilities with respect to the financial reports and other financial information provided by GM to the stockholders and others; GM’s system of internal controls; GM’s compliance procedures for the employee code of ethics and standards of business conduct; and GM’s audit, accounting, and financial reporting processes.
Erroll B. Davis Jr., Kent Kresa and Philip A. Laskawy comprise the Audit Committee. Our Board has determined that all of the members of the Committee are independent, financially literate, and have accounting or related financial management expertise as required by the NYSE. The Board also has determined that Mr. Davis, Mr. Kresa, and Mr. Laskawy (Chair) all qualify as “audit committee financial experts” as defined by the SEC.
Currently, Mr. Laskawy serves on the audit committees of four public companies in addition to our Audit Committee. The Board has determined, in light of Mr. Laskawy’s depth of knowledge and experience and time available as a retiree, that this simultaneous service does not impair his ability to function as a member and the Chair of the Audit Committee.
Late last week, all three of these Board members were said to have been reappointed to the Board and Audit Committee for the new post-bankruptcy GM Board, managing GM now majority owned by the US taxpayer.
Philip A. Laskawy, Age 68, has been a member of our Board of Directors since January 2003. From 1994 to 200l, he served as Chairman and Chief Executive Officer of Ernst & Young LLP. He currently serves as non-executive Chairman of the Board of Directors for the Federal National Mortgage Association, and as a director for Henry Schein, Inc., Lazard Ltd, and Loews Corporation.
You’d think that at as Chairman of the Board of Fannie Mae, Mr. Laskawy could be excused for being quite busy. But it’s a prime example of the ongoing perception that only former Big 4 Chairman are qualified to be Audit Committee Chairman of Fortune 500 corporations, charged with overseeing other Big 4 audit firms. There is such a dearth of “financial experts” that the 68-year-old retired Chairman of EY is needed to be the Chairman of the Board of Fannie Mae, Chairman of the Audit Committee of GM as well as on the audit committee of three other major corporations.
Kent Kresa, Age 71, has been a member of the GM Board of Directors since October 2003. He has served as Chairman Emeritus of Northrop Grumman Corporation since 2003, and he held the offices of Chairman and Chief Executive Officer from 1990 to 2003. He currently serves as Chairman of the Board of Directors for Avery Dennison Corporation, and as a director for Flour Corporation and MannKind Corporation.
Erroll B. Davis, Jr., Age 66, has been a member of the GM Board of Directors since June 2007. He has served as Chancellor of the University System of Georgia, the governing and management authority of public higher education in Georgia, since 2006. From 2000 to 2006, Mr. Davis served as Chairman of Alliant Energy Corporation, and he held the offices of President and Chief Executive Officer from 1998 to 2005. He is currently a director of BP p.l.c., and Union Pacific Corporation.
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