Restoring American Financial Stability Act of 2010: Reforming the Independent Director Standard and Federalizing Executive Compensation

The executive compensation provisions provide for say on pay, clawbacks and increased disclosure.  Relying on listing standards, they require that the compensation committee have independent directors.  The Bill also regulates the compensation consultant and counsel hired by the committee.  It stops short of requiring that they be independent but specifies the factors that must be considered in making the selection.  Presumably consideration of the factors will result in the use of independent consultants and counsel. 

The legislation contains two sleeper provisions, both of which have been mentioned on this Blog before.  First, the directors on the compensation committee must be independent.  The legislation, however, provides that the Commission with the authority to dictate the definition.  Specifically, Section 952 provides that the Commission "shall require" the exchanges to adopt a definition that requires the consideration of "relevant factors" including "compensatory fees" paid by the company to the director.  In other words, unlike the current approach, fees will matter. 

It is also possible that, by giving the Commission the authority to determine "relevant factors," the Commission will further expand the definition to include other relevant factors.  Thus, the Commission could correct the problem that surfaced in connection with the Black & Decker, Stanley Works merger and require the exchanges to consider material relationships among directors (we will revisit this issue next week).  In short, the definition of independence will fall to the Commission and, as a result, it may become more meaningful.

The second sleeper provision, as noted in an earlier post, the legislation authorizes the Federal Reserve Board to adopt rules that prohibit "excessive" compensation paid to executive officers, directors, employees or principal shareholders of bank holding companies.  This is, in short, substantive regulation of executive compensation.  Moreover, by federalizing the issue, it effectively preempts Delaware.   

We've included the text of the compensation provisions.  The entire act is posted on the DU Corporate Governance web site.

Subtitle E—Accountability and Executive Compensation

SEC. 951. SHAREHOLDER VOTE ON EXECUTIVE COMPENSATION DISCLOSURES.
The Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.) is amended by inserting after section 14 (15
U.S.C. 78n) the following:

SEC. 14A. ANNUAL SHAREHOLDER APPROVAL OF EXECUTIVE COMPENSATION.

(a) SEPARATE RESOLUTION REQUIRED.—Any proxy or consent or authorization for an annual or other
meeting of the shareholders occurring after the end of the 6-month period beginning on the date of enactment of this section, for which the proxy solicitation rules of the Commission require compensation disclosure, shall include a separate resolution subject to shareholder vote to approve the compensation of executives, as disclosed pursuant to section 229.402 of title 17, Code of Federal Regulations,
or any successor thereto. 

(b) RULE OF CONSTRUCTION.—The shareholder vote referred to in subsection (a) shall not be binding on
the issuer or the board of directors of an issuer, and may not be construed—

(1) as overruling a decision by such issuer or board of directors;
(2) to create or imply any change to the fiduciary duties of such issuer or board of directors;
(3) to create or imply any additional fiduciary
duties for such issuer or board of directors; or
(4) to restrict or limit the ability of shareholders to make proposals for inclusion in proxy materials related to executive compensation.’’.

SEC. 952. COMPENSATION COMMITTEE INDEPENDENCE.
The Securities Exchange Act of 1934 (15 U.S.C. 78 et seq.) is amended by inserting after section 10B, as
added by section 753, the following:

SEC. 10C. COMPENSATION COMMITTEES.

(a) INDEPENDENCE OF COMPENSATION COMMITTEES.—

(1) LISTING STANDARDS.—The Commission shall, by rule, direct the national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that does not comply with the requirements of this subsection.

(2) INDEPENDENCE OF COMPENSATION COMMITTEES.—The rules of the Commission under paragraph (1) shall require that each member of the compensation committee of the board of directors of an issuer be—
(A) a member of the board of directors of the issuer; and
(B) independent.

(3) INDEPENDENCE.—The rules of the Commission under paragraph (1) shall require that, in determining the definition of the term ‘independence’ for purposes of paragraph (2), the national securities exchanges and the national securities associations shall consider relevant factors, including—
(A) the source of compensation of a member of the board of directors of an issuer, including any consulting, advisory, or other compensatory fee paid by the issuer to such member of the board of directors; and (B) whether a member of the board of directors of an issuer is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary of the issuer.

(4) EXEMPTION AUTHORITY.—The rules of the Commission under paragraph (1) shall permit a national securities exchange or a national securities association to exempt a particular relationship from
the requirements of paragraph (2), with respect to the members of a compensation committee, as the
national securities exchange or national securities association determines is appropriate, taking into
consideration the size of an issuer and any other relevant factors.

(b) INDEPENDENCE OF COMPENSATION CONSULTANTS AND OTHER COMPENSATION COMMITTEE ADVIS15
ERS.—

(1) IN GENERAL.—The compensation committee of an issuer may only select a compensation
consultant, legal counsel, or other adviser to the compensation committee after taking into consideration the factors identified by the Commission under paragraph (2).

(2) RULES.—The Commission shall identify factors that affect the independence of a compensation consultant, legal counsel, or other adviser to a compensation committee of an issuer, including—
(A) the provision of other services to the issuer by the person that employs the compensation consultant, legal counsel, or other adviser;
(B) the amount of fees received from the issuer by the person that employs the compensation consultant, legal counsel, or other adviser, as a percentage of the total revenue of
the person that employs the compensation consultant, legal counsel, or other adviser;
(C) the policies and procedures of the person that employs the compensation consultant, legal counsel, or other adviser that are designed to prevent conflicts of interest;
(D) any business or personal relationship of the compensation consultant, legal counsel,
or other adviser with a member of the compensation committee; and
(E) any stock of the issuer owned by the compensation consultant, legal counsel, or other
adviser.

(c) COMPENSATION COMMITTEE AUTHORITY RELATING TO COMPENSATION CONSULTANTS.—
(1) AUTHORITY TO RETAIN COMPENSATION CONSULTANT.—

(A) IN GENERAL.—The compensation committee of an issuer, in its capacity as a committee of the board of directors, may, in its sole discretion, retain or obtain the advice of a compensation consultant.

(B) DIRECT RESPONSIBILITY OF COMPENSATION COMMITTEE.—The compensation committee of an issuer shall be directly responsible for the appointment, compensation, and oversight of the work of a compensation consultant.

(C) RULE OF CONSTRUCTION.—This paragraph may not be construed—
(i) to require the compensation committee to implement or act consistently with the advice or recommendations of the compensation consultant; or
(ii) to affect the ability or obligation of a compensation committee to exercise its own judgment in fulfillment of the duties of the compensation committee.

(2) DISCLOSURE.—In any proxy or consent solicitation material for an annual meeting of the
shareholders (or a special meeting in lieu of the annual meeting) occurring on or after the date that is 1 year after the date of enactment of this section, each issuer shall disclose in the proxy or consent
material, in accordance with regulations of the Commission, whether—
(A) the compensation committee of the issuer retained or obtained the advice of a compensation consultant; and
(B) the work of the compensation committee has raised any conflict of interest and, if so, the nature of the conflict and how the conflict is being addressed.

(d) AUTHORITY TO ENGAGE INDEPENDENT LEGAL COUNSEL AND OTHER ADVISERS.—
(1) IN GENERAL.—The compensation committee of an issuer, in its capacity as a committee
of the board of directors, may, in its sole discretion, retain and obtain the advice of independent legal
counsel and other advisers. 
(2) DIRECT RESPONSIBILITY OF COMPENSATION COMMITTEE.—The compensation committee of
an issuer shall be directly responsible for the appointment, compensation, and oversight of the work
of independent legal counsel and other advisers.
(3) RULE OF CONSTRUCTION.—This subsection may not be construed—

(A) to require a compensation committee to implement or act consistently with the advice
or recommendations of independent legal counsel or other advisers under this subsection; or
(B) to affect the ability or obligation of a compensation committee to exercise its own
judgment in fulfillment of the duties of the compensation committee.

(e) COMPENSATION OF COMPENSATION CONSULTANTS, INDEPENDENT LEGAL COUNSEL, AND OTHER ADVISORS.—Each issuer shall provide for appropriate funding, as determined by the compensation committee in its capacity as a committee of the board of directors, for payment of reasonable compensation—

(1) to a compensation consultant; and
(2) to independent legal counsel or any other adviser to the compensation committee.

(f) COMMISSION RULES.—
(1) IN GENERAL.—Not later than 360 days after the date of enactment of this section, the Commission shall, by rule, direct the national securities exchanges and national securities associations to
prohibit the listing of any security of an issuer that is not in compliance with the requirements of this
section.

(2) OPPORTUNITY TO CURE DEFECTS.—The rules of the Commission under paragraph (1) shall
provide for appropriate procedures for an issuer to have a reasonable opportunity to cure any defects
that would be the basis for the prohibition under paragraph (1), before the imposition of such prohibition.
(3) EXEMPTION AUTHORITY.—

(A) IN GENERAL.—The rules of the Commission under paragraph (1) shall permit a national securities exchange or a national securities association to exempt a category of issuers from the requirements under this section, as the national securities exchange or the national securities association determines is appropriate.

(B) CONSIDERATIONS.—In determining
appropriate exemptions under subparagraph (A), the national securities exchange or the national securities association shall take into account the potential impact of the requirements of this section on smaller reporting issuers.’’.

SEC. 953. EXECUTIVE COMPENSATION DISCLOSURES.
Section 14 of the Securities Exchange Act of 1934 (15 U.S.C. 78n), as amended by this title, is amended by adding at the end the following:

(j) DISCLOSURE OF PAY VERSUS PERFORMANCE.—
The Commission shall, by rule, require each issuer to disclose in the annual proxy statement of the issuer a clear description of any compensation required to be disclosed by the issuer under section 229.402 of title 17, Code of Federal Regulations (or any successor thereto), including information that shows the relationship between executive compensation actually paid and the financial performance
of the issuer, taking into account any change in the value of the shares of stock and dividends of the issuer and any distributions. The disclosure under this subsection may in clude a graphic representation of the information required to be disclosed.

SEC. 954. RECOVERY OF ERRONEOUSLY AWARDED COMPENSATION.

Section 16 of the Securities Exchange Act of 1934 (15 U.S.C. 78p) is amended by adding at the end the following:

(h) RECOVERY OF ERRONEOUSLY AWARDED COMPENSATION POLICY.—
(1) LISTING STANDARDS.—The Commission shall, by rule, direct the national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that does not comply with the requirements of this subsection.
(2) RECOVERY OF FUNDS.—The rules of the Commission under paragraph (1) shall require each
issuer to develop and implement a policy providing—
(A) for disclosure of the policy of the issuer on incentive-based compensation that is based on financial information required to be reported under the securities laws; and
(B) that, in the event that the issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer with any financial reporting requirement under the securities laws, the issuer will recover from any current or former executive officer of the issuer who received incentive-based compensation (including stock options awarded as compensation) during the 3-year period preceding the date on which the issuer is required to prepare an accounting restatement, based on the erroneous data, in excess of what would have been paid to the executive officer under the accounting restatement.

SEC. 955. DISCLOSURE REGARDING EMPLOYEE AND DIRECTOR HEDGING.

Section 14 of the Securities Exchange Act of 1934 (15 U.S.C. 78n), as amended by this title, is amended by adding at the end the following:

(l) DISCLOSURE OF HEDGING BY EMPLOYEES AND DIRECTORS.—The Commission shall, by rule, require each issuer to disclose in the annual proxy statement of the issuer whether any employee or member of the board of directors of the issuer, or any designee of such employee or member, is permitted to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars, and exchange funds) that are designed to hedge or offset any decrease in the market value of equity
securities—

(1) granted to the employee or member of the board of directors by the issuer as part of the compensation of the employee or member of the board of directors; or
(2) held, directly or indirectly, by the employee or member of the board of directors.’’.

SEC. 956. EXCESSIVE COMPENSATION BY HOLDING COMPANIES OF DEPOSITORY INSTITUTIONS.

Section 5 of the Bank Holding Company Act of 1956 (12 U.S.C. 1844) is amended by adding at the end thefollowing:

(h) EXCESSIVE COMPENSATION.—
(1) IN GENERAL.—Not later than 180 days after the transfer date established under section 311
of the Restoring American Financial Stability Act of 2010, the Board of Governors shall, by rule, establish standards prohibiting as an unsafe and unsound practice any compensation plan of a bank holding
company that—
(A) provides an executive officer, employee, director, or principal shareholder of the bank holding company with excessive compensation, fees, or benefits; or
(B) could lead to material financial loss to the bank holding company.
(2) CONSIDERATIONS.—In establishing the standards under paragraph (1), the Board of Governors shall take into consideration the compensation standards described in section 39(c) of the Fed19
eral Deposit Insurance Act (12 U.S.C. 1831p–1(c))