Corporate Governance, Rule 10C-1, and the SEC: Conclusion (Part 9)

Why did the SEC not require that fees for service on the board be included or that the board explicitly consider personal and business relationships between the directors on the compensation committee and executive management?

SEC was apparently convinced by the arguments made by the exchanges.  But with respect to personal and business relationships, the SEC in the case of both rules actually mandated that the factors be considered.  What the Commission did not do was require that the consideration be explicit.  It was enough to have an isolated statement by the Commission buried in a rulemaking release. 

With respect to compensation, the exchanges did not even address the argument that boards were required by Congress to consider the fees paid to directors (or the method of determining the fees).  Even if the exchanges were convincing that it was unnecessary to consider the information, the decision was not discretionary.  Congress required consideration of fees.  The Commission simply ignored the point.

The rules, therefore, reflect a Commission unwilling to use the discretion given to it by Congress to take an active role in defining director independence.  For the most part, the exchanges determined the standards and merely duplicated the language included in the statute.  

There are a few possible explanations for the Commission's stance.  First, this is a matter of substantive corporate governance, something well beyond the usual disclosure mission of the Commission.  Substantive regulation of corporate governance is a new area for the Commission and not one where it has historic expertise.  The approach taken in connection with Rule 10C-1 could reflect an unwillingness to delve any deeper into the substance of corporate governance than the minimum prescribed by Congress. 

This attitude will have to change.  Congress gave the SEC substantive authority over governance in SOX and did it again in Dodd-Frank.  SOX gave the SEC control over audit committees and clawbacks of compensation (with the Commission slow to use the latter).  In Dodd-Frank, the SEC received authority over compensation committees, strengthened clawback authority, rulemaking power to adopt a shareholder access rule, and an obligation to adopt disclosure requirements in the area of conflict mineral and resource extraction payments. Congress clearly expects the SEC to be more involved in the substance of corporate governance.

Second, the explanation may have a structural explanation.  The SEC is sometimes described as a collection of silos that do not always talk to each other.  The requirements in Rule 10C-1 may have foundered on the silo structure. 

Because the matter is a listing standard, it falls under the jurisdiction of Trading and Markets.  That is the division with the authority to oversee the exchanges and self regulatory organizations.  With respect to trading behavior or broker oversight, Trading and Markets has expertise over the content of the rule proposal. 

This is not really true with respect to listing standards.  The content of the listing standard adopted under Rule 10C-1 affects issuers.  Issuer behavior at the Commission is mostly a matter for the Division of Corporation Finance.  That Division has the expertise over matters that affect board behavior. 

Yet the rule was approved by Trading and Markets.  The adopting releases do not reveal any involvement by Corp-Fin.  Trading and Markets has responsibility not because it has expertise over the contents but because the rule originated from an exchange.  Thus, when the exchanges make representations about the behavior of issuers with respect to the determination of directors fees, Trading and Markets has little expertise in assessing the statement. 

All of this suggests that as Congress imposes on the Commission greater and greater involvement in the substance of corporate governance, the SEC will need to consider possible reorganizations.  Implementation and review should go to (or at least involve) the Divisions with the substantive expertise on the subject, not the Divisions that have, for historical reasons, handled the issues in the past.