A Weak Cup of SEC Tea...

About a month ago, the Securities and Exchange Commission proposed some new disclosure rules about compensation consultants and conflicts of interest. The proposed rules would implement Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. But, just like a weak cup of tea, these proposed disclosure rules have no bite.

In short, the proposed rules would require the exchanges to establish listing standards requiring each member of a listed issuer's compensation committee to be an "independent" member of the board of directors. Each exchange would be required to develop a definition of "independent", considering factors like consulting and advisory fees paid by the issuer to the committee member.

Seems like a good idea, right? Independence of the compensation committee serves as an important part of the checks and balances of corporate governance. And in today's environment, checks and balances are needed more than ever.

Here's where the weak cup of tea comes in... The Dodd-Frank Act only requires the exchanges to consider the relevant factors. Consulting and advisory relationships don't preclude independence, like they do under the Sarbanes-Oxley Act of 2002. Consideration of relationships between compensation committee members and the organization doesn't really have the same bite as preclusion, does it?

The tea gets even weaker... Under the proposed rules, listings of securities would be prohibited for any issuer who doesn't provide its compensation committee with the authority - in its sole discretion - to retain or obtain the advice of "compensation advisers": compensation consultants, independent legal counsel, and other advisers. The compensation committee would be directly responsible for the appointment, compensation, and oversight of the work of any compensation adviser.

Just like members of the compensation committee, compensation advisers wouldn't be required to be independent. Instead, the compensation committee would only need to consider factors affecting an adviser's independence, such as:

• other services provided to the issuer by the adviser's employer;
• the amount of fees, as a percentage of total revenue, received by the adviser's employer from the issuer;
• the conflict of interest policies and procedures of the adviser's employer;
• business and personal relationships of the compensation adviser with a compensation committee member;
• ownership of the stock of the issuer by the compensation adviser.

While factors such as these would have to be considered by the compensation committee, they are not independence requirements that must be satisfied. There is no requirement that the adviser selected is in fact independent. 

The SEC has not proposed any "bright-line" thresholds relating to these factors, or to the definition of independence in general. I think this is a good decision on the part of the SEC. After all, so many of these bright-line thresholds are arbitrary. What's the real difference if an adviser's firm earns 25% of its total revenues from the issuer, as opposed to only 23%, or 27%? Implementing hard rules for concepts such as "independence" and "conflict of interest" are very difficult, and situations not considered in the original definition invariably arise in real life. Some things just don't lend themselves to rigid definitions and bright-line thresholds, and have to be looked at on a case by case basis.

What makes this cup of SEC tea weak is not the lack of a formal definition of independence or bright-line thresholds. It's the fact that compensation advisers don't have to be independent, however independence is defined.

 Stephanie R. Thomas is an economic and statistical consultant specializing in EEO issues and employment litigation risk management. For more than a decade, she's been working with businesses and government agencies providing expert analysis. Stephanie has published several articles on examining compensation systems with respect to internal equity, and has appeared on NPR to discuss the gender wage gap. She is the host of The Proactive Employer, and is the founder of Thomas Econometrics. Follow her on Twitter at ProactiveStats.

Comments

[Dan Walter]

As a truly independent compensation consultant, I couldn't agree with you more.

Thanks for the article.

The definition of "independent" can be difficult, but it is made more troublesome by the lobbying of large consulting firms who realize the compensation is often the "foot in the door."

[Stephanie Thomas]

Dan, I agree that getting on the compensation committee is a good way of getting your foot in the door. Too often, though, getting a foot in the door leads to getting into bed, which can be problematic when it comes to independence and objectivity.

[E. James (Jim) Brennan]

Thanks, Stephanie; that is important news to share. And I love your bedroom analogy!

Failure to specify detailed requirements is consistent with IRS reasonable compensation and intermediate sanctions regulations. IRS likewise leaves the onus on the board of directors, probably so they can more easily hold THEM accountable rather than have to pursue the slippery outsiders.

Dan's cogent point also applies to salary surveys. We find that many consultants consider surveys by competing consulting firms to be a similar attempt at "poaching", as if employers "belong to" one consulting firm and engaging others is a forbidden intrusion or a discouraged trespass on a reservation. (We just do surveys and do no consulting, nor do we charge extra to consultants who buy our surveys, so it's not an issue for us, because our business model precludes selling consulting time.)

A forthcoming "outing" of insider exec comp consulting abuses should raise the heat for such more compelling demands for true independence. Stories should surface soon that will make some new headlines and attract additional political regulatory attention.

[Laura Schroeder]

Oh, that picture! No one who reads this will ever be able to take the SEC seriously again...

I love how everyone gets to define their own definition of 'independent.' I really do, it's this sort of fuzzy thinking that creates high-paying jobs out of thin air.