The Full Employment for Exec Comp Lawyers Act of 2009

The last few years have been a boom time for executive pay lawyers. The current recession has only made things better from our standpoint. Consider that during the last five years: Congress subjected virtually all compensation arrangements (not just executive level) to a horrifically complicated tax regime (Section 409A), burdened the compensation arrangements of multinational companies with a second and similarly complicated tax regime (Section 457A) and re-wrote the key pension funding requirements of ERISA; the SEC overhauled the proxy disclosure rules and did so on a “principles” basis which make disclosure decisions more complicated than ever; and FASB mandated expensing of stock options and full balance sheet recognition of benefit plan underfunding. These are just a few of the things that have created demand, and many more are on the way (e.g., new proxy disclosures).

Last Thursday, the Treasury department, on behalf of the President, proposed new legislation titled the “Investor Protection Act of 2009”. The bill covers many of the executive pay items the President has previously discussed. The keystone of the bill is the much anticipated say-on-pay requirement for all public companies. Nothing interesting to note there; the proposal would mandate the typical say on pay vote (i.e., to approve/disapprove compensation as disclosed in the proxy through a nonbinding vote).

The bill also includes a separate shareholder vote on golden parachutes and severance arrangements, which would be required to be held in any shareholder meeting involving a merger. The idea is that, without this vote, companies would wait to adopt golden parachutes until a transaction is announced and thereby avoid the scrutiny of shareholders. Interestingly, the requirement only applies where there is a shareholder vote or proxy solicitation. Until recently, public company M&A transactions were typically structured as “one-step” mergers, which require the approval of the target’s shareholders--thus, a shareholder vote or proxy solicitation is certain to occur. Today, thanks to the SEC’s fixing a technical problem with the tender offer rules, public M&A transactions are increasingly structured as “two -step” mergers. In this structure, the buyer first commences a tender offer to acquire the target’s stock. Buyers acquire at least a majority (and sometimes even 90+%) of the target’s stock in this first step. The second step is to acquire all the remaining stock through a merger. Because the buyer has at least a majority of the target’s stock, the outcome of this second step is a foregone conclusion (as would be any say-on-pay vote). If the buyer obtains enough stock in the first step, there may not even be a shareholder vote in the second step. Long story short, the additional say on pay vote for golden parachutes may not matter very much because companies can use (and are already using) acquisition structures that reduce the role of shareholder votes.

The bill also includes some mostly trivial corporate governance changes. For example, compensation committee members would be subject to different standards of independence, which are similar to those that already apply to audit committee members. The bill also jumps on the independent consultant bandwagon. While comp committees won’t be required as matter of law to have an independent consultant, they would have to explain in the proxy statement why they chose not to do so. This would be one of the only areas in which companies would be required to disclose what they did not do (as opposed to what they did).

Finally, and forming the basis for the title of this post, the bill strongly encourages compensation committees to engage their own independent counsel. This is the first time I can recall that the issue of independent counsel has been advanced as a way to mitigate executive pay problems (independent consultants, on the other hand, have been pushed for years). The bill directs the Treasury to write rules to define independence, but presumably any law firm that is or has recently represented a company or its management would be excluded from representing the comp committee. Again, the legislation does not require committees to engage their own counsel, but the intent of the bill is clear. If the market responds as the White House hopes, thousands of public companies will be looking to hire yet another set of lawyers. Not so long ago, it looked like public companies would not resort to the dueling consultant approach to setting pay (i.e., management’s consultant argues with the committee’s consultant). Today, thanks to proxy disclosures among other things, a large percentage of public companies in fact do use two consultants. Assuming the legislation passes, it will be interesting to see whether committees take the step of hiring independent counsel. It would then be even more interesting to see what the dueling lawyer dynamic does to the pay setting process--though, if the impact of adding the independent consultant is any guide, not much.

Given the scope of the other legislation Congress is already considering, it is certainly possible that this bill goes nowhere. Say-on-pay was strongly supported, and yet ignored, in less complicated times. Nonetheless, the mere fact that the White House has proposed it may mean that the idea of independent counsel for compensation committees will find itself on the ever-present “hot topics” and “emerging trends” lists that every company and comp committee receives. That alone could be enough to change behavior.