Pay regulations Featured

8:00pm EDT August 26, 2009

Numerous pieces of federal legislation have been proposed to control the high compensation costs for executives at public companies. While decisions on the legislation are not expected until later this year, approval would impact disclosures, reporting and corporate governance for public companies.

“Any company registered with the SEC will be affected by these new rules if they are finalized,” says Kevin A. McGill, an attorney with Baker, Donelson, Bearman, Caldwell & Berkowitz, PC.

Smart Business spoke with McGill about the different pieces of legislation, new rules developed by the SEC and how to prepare for possible approval of the legislation.

What are the proposed pieces of legislation?

Sen. Charles Schumer recently introduced legislation to overhaul a number of governance areas. Sen. Schumer’s legislation includes significant provisions, such as:

  • ‘Say-on-pay,’ which gives shareholders an annual, nonbinding vote on executive pay practices
  • ‘Say-on-severance,’ which gives shareholders a nonbinding vote on severance packages for executives following M&A transactions
  • Enhanced proxy access, which makes it easier and cheaper for investors to nominate their own directors
  • Elimination of classified boards, which requires companies to hold annual director elections rather than voting on a portion of the board each year
  • Majority vote standard for director elections, which requires directors to resign if they do not win a majority of votes
  • Independent board chairs
  • Risk management board committees appointed by boards

The Shareholder Empowerment Act was recently introduced by Rep. Gary Peters and goes a bit further than the Schumer legislation. This legislation would implement eight governance reforms highlighted in a Council of Institutional Investors letter to Congress late last year. These include:

  • Majority voting for directors
  • Enhanced proxy access for long-term investors in nominating their own director candidates
  • Elimination of uninstructed broker votes in uncontested director elections
  • Separation of board chair and CEO positions
  • Nonbinding annual shareholder approval of executive compensation
  • Independent compensation consultants
  • Clawbacks of unearned incentive compensation
  • Bar on severance for executives terminated for poor performance

Finally, Sen. Richard Durbin introduced the Excessive Pay Shareholder Approval Act and Excessive Pay Capped Deduction Act of 2009 in May. The first act would require a supermajority shareholder vote — 60 percent — to approve a compensation structure in which any employee is paid 100 times the average employee salary at that company. A company’s proxy statement would also need to include disclosures related to the compensation of the lowest and highest paid employees, average compensation paid to all employees, and total compensation and number of employees paid 100 times the average compensation.

The second act would limit a company’s federal income tax deduction for compensation paid to executives receiving 100 times the average employee compensation. Any amounts paid in excess of this cap would be considered excessive and would not be deductible. Any company paying excessive compensation would be required to file a report with the U.S. Department of Treasury.

What rules does the SEC have in place?

The SEC put fairly extensive proxy statement disclosure rules into place in 2006, but there have been complaints that there was not enough emphasis on compensation policy analysis. The SEC has recently proposed rules that would require a more enhanced discussion about how compensation policies impact a company’s ongoing business. Many companies, primarily in the financial services sector, compensate employees heavily based upon business success and performance. The SEC is looking for a better analysis of how this method of compensating employees may impact business risk, i.e. whether employees of a company or particular business unit are encouraged to take on too much risk in an effort to increase individual compensation. The aim of these new rules would be to allow investors to assess whether a company’s compensation policies are properly aligned with the long-term success of the company.

Currently, the SEC requires a company to include a number of compensation charts in its proxy statement, including disclosures related to option and stock-based compensation. The proposed SEC rules would change the manner in which such compensation is reported in a company’s proxy statement by requiring that option and stock awards be presented in the tables at their aggregate grant date fair value rather than the dollar amount recognized for financial statement presentation.

How can you become educated on the legislation and prepare for possible approval?

Public companies need to be working closely with outside counsel and accountants. Some of these proposed items would require pretty extensive disclosures and could have some serious business impacts, especially if your company’s compensation policies emphasize success-based pay. If you have a good year and certain employees are rewarded for that success, you may not be able to deduct the excess compensation if the 100 times ‘excess compensation’ cap is implemented. You need to be proactive and understand how the legislation and rules might impact your business. Stay tuned, as it will likely be later this year before any new rules are finalized, and we see how many of these areas are impacted.

Kevin A. McGill is an attorney with Baker, Donelson, Bearman, Caldwell & Berkowitz, PC. Reach him at kmcgill@bakerdonelson.com or (404) 443-6704.