Nasdaq reverses course on independence standardsApparently, corporate governance cannot be dictated by the stock exchanges.  As we had blogged about last year, Section 952 of Dodd-Frank required each national securities exchange to review its independence standards for directors who serve on an issuer’s compensation committee.  Each national securities exchange had to ensure that its independence definition considered relevant factors such as (i) the source of the director’s compensation, including any consulting, advisory, or other compensatory fees paid by the listed company and (ii) whether the director has an affiliate relationship with the company.

As it turns out, Nasdaq interpreted the Dodd-Frank requirement to be much stricter than the NYSE.  At the time I suggested that Nasdaq was trying to “out corporate governance” the NYSE by layering on an extra independence requirement of prohibiting any director serving on the compensation committee from accepting “directly or indirectly any consulting, advisory, or other compensatory fee” from the issuer.  I still think that is the case.  As we have blogged about before, the NYSE and Nasdaq are fierce competitors in their attempts to obtain an issuer’s listing.  In fact, Nasdaq stresses that its stringent corporate governance requirements are a reason why an issuer should list on Nasdaq rather that the NYSE.

Well, I thought that Nasdaq’s stringent interpretation of the rule made little sense and that the burden simply outweighed any limited improvement in corporate governance, especially for community banks where directors often maintain some limited business with the issuer.  Apparently, Nasdaq-listed issuers agreed with me and “based on feedback” and indications that the stringent interpretation of Section 952 of Dodd-Frank “could influence a company’s choice of listing venue” Nasdaq quickly reversed course.

Nasdaq has proposed to eliminate the prohibition of compensation committee members from receiving any compensation beyond board fees.  Instead, Nasdaq-listed issuers will merely need to consider whether the compensation impairs the director’s ability to make independent judgments about the issuer’s executive compensation.  Nasdaq’s revised independence requirement is substantially the same as the NYSE.  Nasdaq expects to adopt the rule amendment prior to the start of issuers’ 2014 annual meetings.

Costs of PCAOB proposal greatly outweigh benefitsThe PCAOB’s recently proposed auditing standards aim to “provide investors and other financial statement users with potentially valuable information that investors have expressed interest in receiving but have not had access to in the past” by changing the standard auditor’s report and increasing the auditor’s responsibilities.  Sounds like a lofty goal, except that the information that they are proposing to require auditors to provide is either (i) self-evident; (ii) an infringement on the judgment of the issuer’s audit committee; or (iii) just plain not helpful.  What the proposed auditing standards do accomplish, however, is to add more costs to being a public company just like their last proposal on mandatory auditor rotation.

Critical Audit MattersUnder the proposed auditing standards, an auditor will be required to include a discussion in its auditor’s report about the issuer’s “critical audit matters.”  Difficult, subjective, or complex judgments, items that posed the most difficulty in obtaining sufficient evidence, and items that posed the most difficulty in forming the opinion on the financial statements are deemed to be “critical audit matters.”  While this requirement may seem straightforward at first, the reality is that this “new” information should be self-evident by anyone who knows how to read a financial statement.  Revenue recognition, estimates for allowances, pension assumptions, etc. are typically deemed to be “critical audit matters” by an auditor when planning audit procedures.  These critical accounting policies are already discussed in issuers’ MD&A and in their financial statements.  Further, any investor who actually is looking at the fundamentals of an issuer’s business and historical results should already be highly focused on estimates that, if wrong, could materially impact the financial statements.  Auditors will end up being overly inclusive on what is deemed “critical” for fear of having Continue Reading PCAOB proposal piling on more costs for public companies (again)

Director Pay Practices

Since 2007, executive compensation practices of public companies have been at the forefront of activist shareholders’ and shareholder rights groups’ agendas. Mandatory say-on-pay proposals, enhanced executive compensation disclosure, compensation committee and compensation consultant independence rules are just a few of the recent significant changes to the laws and regulations applicable to public companies in the U.S. Moreover, as we reported in prior blogs, some countries have gone as far as making say-on-pay proposals binding on public companies. In fact, just this year, Switzerland amended its constitution to require binding shareholder say-on-pay votes and other executive compensation limitations for its public companies (also check out Broc Romanek’s blog for a collection of articles related to this topic). However, while public company executives have been in the crosshairs, little attention, if any, has been given to compensation of public company directors.

But that may change as a result of certain director pay practices highlighted by a recent NY Times Deal Book article by Steven Davidoff. The article focuses on two current proxy fights involving hedge funds attempting to get their proposed nominees elected to the boards of Hess Corporation and Agrium Inc. In the first case, the nominating hedge fund is proposing to pay a $30,000 bonus to any of its nominees who ultimately win a seat on the Hess board. Additionally, each such nominee would be eligible to earn a performance bonus based on share performance relative to its peer group. Based on the performance award formula, the maximum potential payout could be as much as $9 million if Hess outperforms its peer group by 300% over a three-year measuring period.

The second case is potentially even more lucrative for the director nominees. In addition to a $50,000 bonus each nominee would receive if elected,  they would also receive 2.6% of Jana Partners’ net profit based on the stock closing price on September 27, 2012. Director nominees not elected would still receive 1.8% of the net profit during that same period. Considering Jana’s total investment in Agrium is over $1 billion, the earning potential could be significant. However, based on the results of the Agrium annual meeting held on April 9, it appears that none of these Jana nominees were elected to the Agrium board this time around.

These arrangements pose some interesting questions from a corporate governance standpoint. Historically, directors Continue Reading Will director compensation be the next target?

Independent ChairmanAre the CEO and the Chairman of the Board the same executive at your company?  While there can be very good reasons to have these positions held by the same person, the separation of these posts continues to be a hotly debated topic.  Since the early 1980s, much attention has been paid to corporate boards of directors and how their structures improve (or undermine) organizational performance. In the wake of the recent financial crisis, public corporations have come under scrutiny from activist shareholders, institutional investors, advisory firms and regulators alike.  So naturally, this is the source of the debate over the separation of the CEO and Chairman positions. 

According to the ISS Governance Exchange, in 2012, investors filed 49 independent chair proposals, with more than three-quarters coming to a vote, including three that received majority support.  As of February 1, 2013, this year’s volume of filings now exceeds last year’s total with 53 firms targeted by shareholders seeking a split of the top posts, with additional filings likely at companies meeting later in the year.  Notably, the record for such proposals was set in 2010, with a total of 66. 

Proponents of CEO and Chair independence base their view on the inherent system of checks and balances that the Board, and particularly the Board’s Chairman, is supposed to impose on management.  Essentially, a firm’s Board and Chairman of the Board serves to hire, fire, evaluate and compensate management (including the CEO) based on performance.  Clearly then, these proponents argue, a single CEO and Chairman cannot perform these tasks apart from his or her personal interests, making it more difficult for the Board to perform its critical functions, if and when the CEO is its Chairman.  Accordingly, separation of the Chairman and CEO roles, can lead to better management and oversight because an independent Chairman is able to ensure that the board is fully engaged with strategy and to evaluate how well that strategy is being implemented by management. Importantly, appointment of an independent Chairman can also signal to all stakeholders that the CEO is accountable to a unified Board with a visible leader. 

But while largely helpful from a corporate governance standpoint, one must note that the separation of CEO and Chair positions can impose several costs on a firm.  First, while appointing an outside Chairman can reduce the agency costs of controlling a CEO’s behavior, such an appointment introduces Continue Reading Separating the positions of CEO and Chairman: The debate rages on

compensation committeesIssuers listed on the NYSE or Nasdaq should pay close attention to the rules proposed by the exchanges last week because the proposed rules will impact compensation committees; however, the impact may be a “tale of two exchanges” because the impact is more significant to Nasdaq-listed companies.  As you may recall, Congress included several provisions in the Dodd-Frank Act to combat perceived public concerns over excessive executive compensation.  One provision, say-on-pay, has been implemented, but other more controversial provisions such as executive compensation clawbacks and executive compensation pay ratios have not been implemented.  Last week, the exchanges proposed rules to implement the independence requirements for compensation committees required under Dodd-Frank. 

As we have mentioned before, Section 952 of the Dodd-Frank Act does not infringe on traditional state corporation law by requiring an issuer to have a compensation committee or to have a compensation committee actually approve executive compensation.  Instead, it directs the exchanges to design and implement their interpretations of corporate governance best practices based on the parameters of Section 952.  The NYSE and Nasdaq proposed rules are different, and I highlight some of the most important aspects of each of the set of rules below.  In general, NYSE-listed companies are impacted significantly less than Nasdaq-listed companies.  

Director Independence  

The SEC rules implementing Section 952 require that the exchanges’ definition of independence consider relevant factors such as (i) the source of the director’s compensation, including any consulting, advisory, or other compensatory fees paid by the listed company and (ii) whether the director has an affiliate relationship with the company.  The two exchanges interpreted the SEC’s rules vastly different.  

The NYSE merely maintains its current definition of “independence” and requires the issuer to consider the two additional factors set out by the SEC.  In practice, it would be highly unlikely that the two additional factors set out by the SEC would impact a board’s assessment of a particular director’s independence.  

Nasdaq’s current definition of “independent director” remains in effect; however, Nasdaq has elected to overlay a separate independence Continue Reading Proposed compensation committee independence rules will impact some issuers more than others

Compensation committees remain on the hot seat.  Stemming from the Dodd-Frank Act, the SEC has adopted rules directing each national securities exchange to require companies with listed equity securities to comply with new compensation committee and compensation advisor requirements. Among other things, these new rules require national securities exchanges to implement listing standards that require :

  • each member of a listed company’s compensation committee to be an “independent” director;
  • the issuer to consider relevant factors (to be determined by the national securities exchange) including, but not limited to, the source of compensation of a member of the compensation committee member and whether a compensation committee member is “affiliated” with the issuer, subsidiary of the issuer, or an affiliate of the subsidiary;
  • an issuer’s compensation committee to have the authority and responsibility to retain compensation advisers and consider the independence of compensation advisers; and
  • require issuers to include specified disclosure about the use of compensation consultants and any related conflicts of interest in the proxy materials for their annual shareholders’ meetings.

As we noted when these rules were originally proposed, the SEC has not infringed on the traditional rights of states to define corporate law because these new rules do not require an issuer to have a compensation committee.  Rather, the new rules require that the independence rules be applied to committees performing functions typically performed by a compensation committee regardless of the name of the committee (compensation committee, human resource committee, etc.).  Under the final rules, the SEC has broadened the independence requirement to apply also to the members of the listed issuer’s board of directors who, in the absence of a compensation committee, oversee executive compensation matters.

The final definition of “independence” for a compensation committee will largely depend on the final rules of each national Continue Reading Are your compensation committee members independent?

Issuers who would not otherwise meet the NASDAQ independence rules may now breathe (a small) sigh of relief. On May 30, the SEC published notice of NASDAQ’s proposed change to Listing Rule 5605.

Generally, Rule 5605 requires issuers to maintain an “independent” audit, compensation, and nominating committees. There is an exception to the independence rules that allows one nonindependent director to serve on one of these key committees under “exceptional and limited circumstances” for up to two years.

Generally, this exception is rarely used — in the two-year period ended December 31, 2011, only 37 issuers used the exception – and is usually used only by the smallest of the listed issuers.

Under the current exception, if a director would not be considered independent because either the Board determined that the director had a relationship that interfered with the director’s independent judgment or if the director failed one of NASDAQ’s objective tests such as being employed by the company or one of its affiliates or accepting certain payments from the company in excess of $120,000 in a year, then the director could serve in an “exceptional and limited circumstance” provided that the company did not employ a family member of that director.

Under the proposed new rules, the director would be permitted to serve provided that the employed family member was not an executive officer.

While the exception does not impact a tremendous amount of companies, it does have a disproportionate benefit to smaller issuers, particularly companies with large shareholders who may be deemed affiliates of the issuer. The expected impact will be small, but I welcome any relief for smaller issuers especially given the tremendous burden placed on smaller issuers over the past 10 years.

 Last week, the SEC proposed new rules required by Section 952 of Dodd-Frank Act.  Under the proposal, compensation committees may engage a compensation consultant or other advisor, including legal counsel, only after taking into consideration the following factors, and any other factors determined by the national securities exchanges:

1) provision of other services to the issuer by the person that employs the advisor;

2) amount of fees received from the issuer by the person that employs the advisor, as a percentage of the total revenue of the person that employs the advisor;

3) policies and procedures of the person that employs the advisor that are designed to prevent conflicts of interest;

4) any business or personal relationship of the advisor with a member of the compensation committee; and

5) any stock of the issuer owned by the advisor.

The SEC has not proposed any bright-line tests or numerical thresholds to assist in determining whether a conflict of interest exists.

In addition, each issuer must disclose in any proxy or consent solicitation for an annual meeting at which directors are to be elected, whether (1) the compensation committee has retained or obtained the advice of a compensation consultant or other advisor, including legal counsel, and (2) the work of the advisor has raised any conflict of interest and, if so, the nature of the conflict and how the conflict is being addressed.  These disclosure rules would apply to all Exchange Act registrants subject to the SEC’s proxy rules.

To review the proposed rules, click here.

Last Wednesday, the SEC proposed new rules required by Section 952 of Dodd-Frank Act.  Under the proposal, each national securities exchange will be required to adopt new listing standards to prohibit the listing of any issuer that is not in compliance with the exchange’s independence requirements for compensation committees.  While compensation committees will need to be comprised entirely of independent directors, each national securities exchange will need to define independence for itself taking into consideration two factors: (1) the source of compensation of a Board member, including any consulting, advisory, or other compensatory fee paid by the issuer to the Board member, and (2) whether a Board member is affiliated with the issuer.  It is important to note that, in passing the Dodd-Frank Act, Congress did not infringe on the traditional role of states in defining corporate law.  There is neither a requirement to actually have a compensation committee nor a requirement for a compensation committee to approve executive compensation.  Any such requirements would be set forth by the national securities exchanges, such as the New York Stock Exchange currently requires.

The independence requirements, as proposed, would be applicable to any committee of the Board that oversees executive compensation, whether or not the committee is formally designated as a “compensation committee.”  While this particular requirement of the proposed rules is an attempt to prevent issuers from evading the independence requirements by renaming the Continue Reading National Securities Exchanges to Adopt New Listing Standards to Ensure Independence of Compensation Committees