Davis Polk & Wardwell Newsflash

Obama Administration to Push for Legislation Mandating Say on Pay and Additional Independence Standards for Compensation Committee For All U.S. Public Companies

June 11, 2009

Yesterday, various agencies of the Federal government announced or released pronouncements and guidance affecting executive compensation and corporate governance.  While some are focused on financial institutions, many, if they go forward, will have sweeping applications to all U.S. public companies. First, Treasury Secretary Timothy Geithner announced a set of broad-based executive compensation principles applicable to all U.S. public companies.  As part of the principles, the Obama administration intends to work with Congress to adopt legislation giving the SEC the authority to (1) require all U.S. public companies to give shareholders a nonbinding vote on executive compensation (say on pay) and (2) impose additional independence requirements on compensation committee members.  In this regard, Treasury issued two fact sheets. The two links below describe the Obama administration's support for say on pay and the imposition of audit committee independence standards on compensation committee members.

Say on Pay

Regarding nonbinding say on pay votes, the fact sheet indicates that:

  • All U.S. public companies would be required to include in their annual proxy statements a resolution allowing shareholders to approve or disapprove executive compensation, including the Compensation Discussion and Analysis and the quantitative disclosure.
  • Shareholders would also be able to vote on annual compensation for the top five named executive officers.
  • Companies would also have the opportunity to ask for shareholders’ views on specific compensation decisions, including those related to various aspects or categories of pay.
  • In shareholder meetings relating to a merger or acquisition, shareholders would be able to cast a nonbinding vote on golden parachute payments.

There is no indication of timing for any proposed legislation or possible effectiveness.  As we have previously indicated in the Davis Polk client newsflash "Senator Schumer Proposes Key Governance Changes for U.S. Public Companies", Senator Charles Schumer has introduced legislation to require that all U.S. public companies provide their shareholders with say on pay votes.  Currently, a company proposal seeking such a vote triggers a requirement for filing a preliminary proxy statement, which is subject to possible SEC staff review, and at minimum companies must wait at least ten days after the initial filing before mailing the definitive statement to shareholders.  The SEC is likely to be given sufficient authority to modify this requirement if it chooses.

It is worth noting that while say on pay shareholder proposals have gained momentum this year as compared to prior years, only 16 proposals have received majority support as of late May, according to RiskMetrics Group.  While many such proposals received high supporting votes (above 40 or 45 percent), it appears that say on pay shareholder proposals will be approved by a majority at about one-third, if not fewer, of the 70 or so companies where they were voted on.

Additional Independence and Other Standards for Compensation Committees

According to this fact sheet, the Administration intends to propose legislation that would direct the SEC to impose upon members of the compensation committee the same additional independence standards that audit committee members became subject to pursuant to the Sarbanes-Oxley Act, as codified in Exchange Act Rule 10A-3.  These additional standards may mean that a compensation committee member may not (1) accept directly or indirectly any consulting, advisory or other compensatory fee from the company or any subsidiary; or (2) be an affiliated person of the company or any subsidiary.

It is unclear whether the interpretations applicable to the independence of audit committee members that are in the SEC release adopting Rule 10A-3 would also become applicable to compensation committees.  In addition, compensation committees may also be affected by the fact that the listing exchanges are not able to exempt controlled companies from Rule 10A-3 requirements for audit committee members.

To provide compensation committees with additional authority, the fact sheet borrows from other provisions currently applicable to audit committees.  Compensation committees would be directly responsible for any compensation consultants they retain, would have the authority to engage counsel and other advisers and obtain appropriate funding.  The SEC must also establish standards for ensuring the independence of compensation consultants and outside counsel used by compensation consultants.

Other Broad-Based Compensation Principles Announced

The statement by Secretary Geithner to which the two fact sheets were attached announced the following principles for executive compensation at all U.S. public companies, especially in the financial sector:

  • Pay for performance: Compensation should be tied to performance in order to link the incentives of executives and employees with long-term value creation.  Performance-based pay should be conditioned on a wide range of metrics, and not simply stock price.
  • Risk time horizon: Compensation should be structured to account for the time horizon of risks.  While observing that stock holding periods and clawbacks may accomplish this, the Secretary noted that “directors and experts should have the flexibility to determine how best to align incentives in different settings and industries.”
  • Risk management: Compensation committees should conduct and publish risk assessments of pay packages to ensure that they do not encourage imprudent risk-taking.  Companies should provide risk managers with the appropriate tools and authority to effectively manage risk.
  • Golden parachutes and supplemental retirement pay: Companies should reexamine how well golden parachutes and supplemental retirement packages are aligned with shareholders’ interests, whether they incentivize performance and whether they reward executives even if shareholders lose value.

In setting forth these principles, the Secretary specifically disclaimed any intention for the Treasury to cap compensation, or prescribe how companies should set compensation. Rather, he purported to be developing standards that reward innovation and prudent risk-taking. A similar set of principles is also included in the TARP executive compensation regulations (referenced below) package, as a guide for the newly appointed Special Master for TARP Executive Compensation.

SEC Upcoming Proxy Disclosure Rules

Also, yesterday, SEC Chairman Mary Schapiro announced that the SEC is actively considering a package of new proxy disclosure rules, much of which has already been reported in the media and other outlets, that is intended to provide further transparency on compensation decisions for all U.S. public companies.  These items receiving additional transparency include:

  • how a company, and its board, manages risks;
  • a company’s overall compensation approach;
  • potential conflicts of interest by compensation consultants, including disclosure of relationships between the consultants and the company and their affiliates;
  • information about director nominees, including their experience and qualifications to serve on the board or on particular board committees; and
  • why a board has chosen its particular leadership structure. 

Other Regulatory Initiatives

To round out an extremely busy day in Washington’s compensation and governance regulatory circles, the SEC finally released the text of its proposal to permit shareholders to nominate directors through a company’s proxy statement, Facilitating Shareholder Director Nominations (the “proxy access proposal”) and Treasury also released its long-awaited guidelines on executive compensation for institutions that have received Federal government assistance.  We will be writing client memoranda on both topics and following the continuing development of these related initiatives.


If you have questions regarding this newsflash, please contact any of the lawyers listed below or your regular Davis Polk contact.

Ning Chiu, Counsel
212-450-4908 | ning.chiu@dpw.com

Barbara Nims, Partner
212-450-4591 | barbara.nims@dpw.com

Kyoko Takahashi Lin, Partner
212-450-4706 | kyoko.lin@dpw.com


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