September 30, 2010
Dodd-Frank Could Have Been Worse, Much Worse
Some are proclaiming the Dodd-Frank financial reform act to be the most important piece of financial legislation since Sarbanes-Oxley. Essentially, the Act ushers in changes in the governance of executive compensation in four primary areas: (1) non-binding Say on Pay; (2) clawbacks in the case of any material financial restatement; (3) increased disclosure around the relationship between executive pay and performance, and pay equity; and (4) rules around compensation committee member independence and compensation consultant independence. But in reality, the Dodd-Frank Act could have been worse . . . much worse.
To be sure, the devil is in the details, and my guess is that we’ll be waiting for several months before we find out just how most of these provisions are to be implemented. But let’s talk about some of the things that Dodd-Frank did not hit us with. For one thing, Dodd-Frank did not affect the tax code as it pertains to executive compensation. Changing the tax code, like 162(m) did back in 1993, always carries unintended consequences. Second, the act gives shareholders the right to a non-binding vote on pay. While companies shouldn’t be cavalier about shareholder sentiments, companies can chose whether and how they will respond to the vote. Further, companies can recommend that this shareholder polling be done as infrequently as once every three years. Third, compensation committees will need to have considered factors that will have led them to believe that their compensation consultants are independent, but for the most part, compensation committees will still be able to retain their consultants of choice. Finally, most of the Dodd-Frank regulations won’t go into effect for quite some time, giving companies plenty of time to determine how they will address the likely requirements of the Act. Because the SEC was not rushed to immediate action, it doesn’t appear as though the law is as urgent as some may claim.
Still, corporations should take the new law seriously. Unless the company’s proxy is due out in the first quarter of 2011, the most significant thing that companies can do now is plan. In other words, companies can take time to think through their responses, as the SEC figures out how it will extract that devil who is hiding in the details.