Dodd-Frank: What It Means for Comp and Governance

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Clawback Difficulties

The "clawback" provision of the law is a knotty issue and will require SEC guidance. For example, the three-year period does not start on the date of the restatement but on the date the company is "required to prepare the restatement." Since the requirement to prepare a restatement exists on the date the erroneous statement is issued—at least in certain cases—the requirement could be read to apply only to incentive compensation granted before the erroneous financial statement was first issued, which is obviously not what was intended. Also, in cases where the delivery of incentive compensation is not directly tied to a specific performance metric, guidance is needed about how to determine what percentage of incentive compensation was based on the erroneous financial statement.

The impact of the new hedging disclosure rules is open to question but could result in executives and directors "going naked" in the market if companies decide to prohibit hedging. This could have the effect of penalizing directors and named executives if severe stock declines happen through no fault of their own, as occurred in the present recession, and may result in increased insider sale transactions as diversification is used in lieu of hedging strategies.

Prohibitions on discretionary broker voting will end the practice of voting automatically with company recommendations, and a large number of nonvotes will increase the power and influence of the investors who do vote. This will create administrative complexities and shareholder communication challenges for companies with a high percentage of retail investors, since an outreach program may be needed to encourage voting.

The rule to disclose the decision whether to have the same person or different persons serve as board chair and CEO represents a modest expansion of a current proxy rule and should have limited impact on boards.

Overall Effect?

The impact of the new rules applicable to banks and other financial institutions is unclear. From a disclosure perspective, we anticipate that more detail with regard to compensation arrangements, including those below the senior executive level, will be required. This may be complicated and administratively cumbersome. The prohibition against incentive-based compensation arrangements that may encourage inappropriate risks by providing excessive compensation, fees, or benefits or that could lead to material financial loss to the institution could lead to major changes in compensation design and delivery. Similar rules have been adopted in several European countries, and it appears they will require major change in the structure (i.e., less cash, more equity) and timing of compensation payments (less immediate, more deferred and subject to clawback if investments deteriorate). It is unclear whether comparable restrictions will be imposed in the U.S., but guidelines should be issued within nine months.

While it is too early to predict a decline in executive compensation as a result of the law, there will be pressure on companies that aren't performing to reduce compensation in line with current operating results and changes in shareholder value. This may be resisted, but the law provides leverage to shareholders that will be hard for management and directors to ignore.

Ryterband is president of Frederic C. Cook & Co., a national independent consulting firm dedicated to assisting clients with compensation plan design for executives, key employees, and boards of directors.

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