One of the propositions on which most commentators seem to agree is that perverse compensation incentives helped fuel the global economic crisis. For example, last Wednesday, formed Fed Chairman Paul Volcker said in a speech that one of the causes of the financial crisis "was the ultimately explosive combination of compensation practices that provided enormous incentives to take risk." Other commentators have made similar assertions.
Given these sentiments, it comes as no surprise that among the first reform initiatives to emerge in the wake of the economic crisis are proposals to regulate compensation practices.
The most attention-grabbing example of this compensation-related reform agenda is last week’s news that the Federal Reserve is planning to issue bank compensation rules that would, according to the Wall Street Journal (here), "inject government regulators deep into compensation decisions traditionally reserved for the banks’ corporate boards and executives." Under this plan, the Fed would review – and could reject or amend – any compensation policies to make sure they "don’t create harmful incentives."
If these reforms are enacted, they could represent a significant potential expansion of bank board liability exposures. As reflected in a September 19, 2009 Wall Street Journal article entitled "Boards Face Expanded Responsibilities" (here), the proposed Fed rules "could increase time demands, recruitment challenges and legal exposures for boards."
Because the proposed Fed plan could lead to the Fed’s review of compensation for "many lower-level employees, such as big traders and groups of loan officers," the plan could "force directors to scrutinize pay practices for more employees," as "board members might have to keep tabs on pay arrangement for thousands of employees."
The Fed plan is not the only reform initiative that could impose increased compensation-related burdens on corporate boards. As detailed in a September 17, 2009 memorandum from the Pillsbury Winthrop Shaw Pittman law firm entitled "Executive Pay Reform Poses Complex Risks for Compensation Committees" (here), there are a variety of legislative proposals now working their way through Congress that could impose increased compensation-related burdens on corporate boards.
Of particular interest here is H.R. 3269, The Corporate and Financial Institution Compensation Fairness Act of 2009, which passed the House on July 31, 2009, and has now moved to the Senate for further review and possible amendment. According to the law firm memo, the Senate is likely to address the Act before the end of the year.
As described in the legal memo, the Act among other things embodies the principle that "the process of establishing executive compensation schemes should be transparent, protect against bias and provide enhanced accountability." The memo goes on to note that "notwithstanding passage of the Act, evolving corporate governance practices and pressures from shareholder advocates will ensure an enhanced role for compensation committees in fashioning the next generation of executive compensation policies and programs."
The bottom line is that as a result of regulatory, legislative and other initiatives, boards will face an increased array of compensation-related burdens and responsibilities. These burdens will not only increase the amount of time and effort that boards will be required to spend on compensation issues; they could also expand the board’s potential liability exposures regarding compensation issues.
In a prior post (here), I noted that Executive Compensation may be the "new front line in the litigation wars." The various regulatory and legislative initiatives now emerging seem likely to ensure that compensation issues will define the front line of the litigation wars for years to come.
Will Industry Get Out in Front on This Issue?: Many companies and their executives are well aware of the possibility of regulatory or legislative action regarding compensation issues, and at least some of them are working hard to get out in front of the issue. In that regard, on September 21, 2009, The Conference Board issued a report on the topic of executive compensation, containing proposals echoing the sentiments and even some of the specifics of the regulatory and legislative initiatives. A copy of the report can be found here.
As reflected in the September 21 press release, the recommendations are intended to try "to restore credibility and increase trust in pay practices and oversight." The recommendations include certain "Guiding Principles," including try to "establish a clear link between pay, strategy and performance." The Principles also recommend that public companies should "foster transparency with respect to compensation practices and appropriate dialogue between boards and shareholders."
A September 21, 2009 Bloomberg article about The Conference Board's report and proposals can be found here.
Subprime Update: The Interview: On September 21, 2009, Bruce Carton of the Securities Docket interviewed me in connection with my recent interim update on the subprime and credit crisis class action securities litigation. The interview can be found on Securities Docket, here, and is also embedded below. My prior post with my detailed update about the subprime and credit crisis litigation can be found here.