Obama Administration Proposes Legislation Mandating Say-on-Pay and Independent Compensation Committees

The Obama Administration has asked Congress to pass legislation mandating a non-binding shareholder advisory vote on executive compensation. The Administration also seeks legislation ensuring the independence of board of directors' compensation committees similar to the manner in which the Sarbanes-Oxley Act provided for independent audit committees. Congressional oversight chairs quickly expressed support for the legislative proposal.

Senate Banking Committee Chair Christopher Dodd (D-CT) said that he strongly supports say-on-pay legislation. He said that executive compensation has spun completely out of control by rewarding short-term gain and encouraging excessive risk-taking. House Financial Services Committee Chair Barney Frank (D-MA) also supports say-on-pay legislation, but does not think simply mandating independent compensation committees goes far enough. He believes that the legislation should also direct the SEC to set principles preventing companies from providing compensation systems that lead to excessive risk taking.

The legislation would direct all public companies to include in their annual proxy statements a shareholder resolution requesting approval or disapproval of executive compensation as disclosed in the proxy, including the narrative description of the board's compensation decisions in the Compensation Discussion and Analysis and the quantitative disclosure of the amounts executives are entitled to receive.

Shareholders would have the right to vote on annual compensation for the top five named executive officers as disclosed in the company's proxy statement. Currently, SEC regulations designate the CEO, the CFO and the next three most highly-paid officers other than the CEO and CFO as the five named executive officers whose compensation must be disclosed. The types of compensation shareholders will have the opportunity to evaluate include salary, bonus, stock awards, option awards, non-equity incentive plan compensation, change in pension value and non-qualified deferred compensation earnings.

Consistent with the say-on-pay legislation President Obama co-sponsored while in the Senate, shareholders will have the opportunity to cast a non-binding vote to approve or disapprove golden parachute compensation disclosed in proxy solicitation materials prepared for shareholder meetings relating to a merger, an acquisition or any other transactions that may involve a change in control.

Although the shareholder vote will be non-binding, experience shows that the prospect of the vote itself can cause directors to more carefully to consider shareholder interests when designing executive pay. The Administration believes that giving shareholders a way to express their views on executive compensation will allow boards and shareholders to work together to design compensation that gives executives strong incentives to maximize long-term firm value, which is a key reform goal endorsed by the G-20 and the Financial Stability Board.

The Administration believes that many of the compensation practices that encouraged the excessive risk-taking that contributed to the financial crisis might have been more closely scrutinized if compensation committees had greater independence and shareholders had more clarity. In too many cases, compensation committees were not sufficiently independent of management, while companies were not fully transparent in explaining their compensation packages to shareholders.

The proposed legislation would also direct the SEC to adopt rules requiring that companies have independent compensation committees similar to those for audit committee members under the Sarbanes-Oxley Act. The regulations must ensure that compensation committee members will be truly independent when setting executive pay on behalf of shareholders.

Just as the Sarbanes-Oxley Act gave audit committees the power to retain and dismiss outside auditors, the new requirements would enable compensation committees to use outside advisers in the process of setting executive pay. Under the proposal, compensation committees would be directly responsible for the appointment, compensation, retention and oversight of the work of any compensation consultants that they retain. The compensation consultants would report directly to the compensation committee. The compensation committee also would have the authority to engage counsel and other advisers as it determines necessary to carry out its duties.

The legislation would mandate that each company must provide appropriate funding, as determined by the compensation committee, to enable the committee to engage and adequately compensate compensation consultants, outside counsel and any other advisers employed by the compensation committee. Further, the legislation would direct the SEC to establish standards for ensuring the independence of compensation consultants and outside counsel used by the compensation committee.

Senator Charles Schumer (D-MA) has sponsored a bill requiring say on pay as part of a broad shareholder rights reform package. The Shareholder Bill of Rights Act, S. 1074, would require public companies to hold an annual advisory vote on executive compensation policies and would require shareholder approval of executive golden parachutes.