In a move that further weakens executives’ influence over the setting of their compensation, public companies will soon face new requirements that they disclose any conflicts of interest involving their compensation consultants in their proxy statements.
The Securities and Exchange Commission mandated that U.S. stock exchanges propose new listing standards to that effect this September, standards that are to take effect next June.
Robin Ferracone, CEO of the executive compensation consultancy Farient Advisors, says the new standards are no surprise. “The SEC didn’t depart much from what the Dodd-Frank Financial Reform Act called for so my sense is that most of this has already been taken into account by public company boards.”
“Dodd-Frank has already had a significant impact on executive compensation,” Ferracone adds. “This is another step in shifting the power over executive compensation into the hands of the board compensation committees, and not the executives, because with these new standards, there is no ambiguity about who the executive consultants are working for: it’s the compensation committees.”
Most companies and executive compensation consultancies have long known the new regulations were coming, agrees Amy Seidel, a partner with the Minneapolis law firm of Faegre Baker Daniels. “These new rules have been a long time in the making, and this also tracks what was done with respect to insuring the independence of audits.”
Seidel says most of the large compensation consultants that were units of bigger organizations, which might have posed conflicts because of work the parent did for the same corporate clients, have already been spun off as independent companies. “We’ve seen a lot of cleaning up of the compensation consulting business,” she says.
The new rules being developed by the exchanges for their listed companies are “about disclosure, not about prohibiting using specific consultancies,” Seidel stresses, and says there’s a good reason for this. “There’s a finite number of consultancies and so actually the prospect of various potential conflicts of interest are quite significant.”
The fact that a conflict or potential conflict might exist—like a board of director’s compensation committee employing a consultancy where a relative of one of the company’s top executives or of a member of the board works—doesn’t mean the company can’t use the consultancy. Rather, the company would have to include a note on that relationship in its proxy, along with an explanation of why it felt the relationship would not pose a problem or interfere with the consultancy’s ability to act independently.
Given the amount of controversy among shareholders about executive compensation packages and the concern expressed by regulators, Seidel says most companies have been acting to eliminate potential conflicts, including changing consultants when conflicts have been identified. “I think with these new rules, there will be fairly few board discussions about relationships that had not been known about already,” she says.
Deborah Lifshey, managing director of the executive compensation consultancy Pearl Meyer Partners in New York City, says one result is that board compensation committees are “asking to see the consultants’ conflict-of-interest policies.”
“They want to know if we have one, and how we’re dealing with the issues raised by the SEC. They want to see it on paper and see it all laid out and defined,” Lifshey says. “More and more, they also want to see an independence certification letter from us on an annual basis."
For a look at whether a proposed audit standard on related-party transactions will focus more attention on executive compensation, see Audit Eye on Executive Pay. And for a look at CFO compensation, see Treasury & Risk’s 2012 survey on CFO pay.