The Securities and Exchange Commission does not require compensation committee members to be "independent," but companies will have to disclose potential conflicts of interest, according to the proposed rule, which is similar to the rules regarding comp committee advisers.
Business groups are generally happy with the U.S. Securities and Exchange Commission's proposal requiring independence of board compensation committees, although they are resisting new disclosures about compensation consultants.
The SEC's proposed rule is another of the many proposed and final rules flowing out of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which added Section 10C to the Securities Exchange Act of 1934.
Section 10C requires the Commission to adopt rules directing the national securities exchanges -- the big players are the New York Stock Exchange, Euronext and NASDEQ -- to establish guidelines for the ways companies must determine whether comp committee members are independent.
The legislation does not require compensation consultants to be independent, but companies may have to disclose in their annual reports potential consultant conflicts beyond what is currently required in Regulation S-K.
Dodd-Frank's guidelines, and the SEC's translation of them into regulatory language, generally track the independence rules already in place at the exchanges with regard to boards of directors generally.
The SEC proposed rule doesn't define "independent," but rather discusses two "relevant factors" -- set out in Dodd-Frank -- that companies must use in coming up with their own definition. Those are: (1) whether a compensation committee director receives compensation for consulting, advisory or other services from the company and (2) whether a compensation committee member is affiliated with the issuer, a subsidiary of the issuer or an affiliate of a subsidiary of the issuer.
"The Center agrees with the Commission's approach and believes that it provides exchanges with the flexibility to tailor independence standards that will be appropriate for their member companies," says Timothy J. Bartl, senior vice president and general counsel of the Center on Executive Compensation, which is affiliated with the HR Policy Association.
But governance groups and labor unions want the SEC to specify additional relevant factors.
Justin Levis, senior research associate of Washington-based Council of Institutional Investors, says companies should also consider whether a compensation committee director has family ties to company executives or relationships with other directors. The CII is a nonprofit association of employee benefit funds and foundations that advocates for strong corporate governance.
While Dodd-Frank does not require independence, it does require the compensation committee to consider at least five "competitively neutral" independence factors -- such as whether the consultant has a "business relationship" with a compensation committee member -- before selecting a compensation adviser.
The company then has to disclose in its annual report whether any of those five factors raised potential conflict-of-interest questions hey were dealt with.
Some compensation consultants have taken opposite views of the clarity of some of those five factors. Donald Kalfen, a partner with Lake Forrest, Ill.-based Meridian Compensation Partners, says the term "business relationship" is inherently ambiguous and therefore requires rulemaking for clarification.
William H. Ferguson, senior partner of global segment leader for rewards at New York-based, Mercer, disagrees. "We do not believe the Commission needs to more fully define the term 'business or personal relationships' as the myriad possible definitions and considerations are unlikely to be fully encompassed by such a definition."
Nonetheless, the five factors essentially track with the SEC's current compensation-consultant disclosure requirements.
Where Dodd-Frank diverges from current law is that it requires disclosure when a company's compensation consultant buys non-customized benchmark salary data from another consulting firm that may be doing healthcare or pension consulting for the company.
The SEC had exempted companies from disclosing this information when it is obtained from other consultants also working for the company in non-compensation areas, such as healthcare. Currently, Bartl says, the identity of the second company and how much the consultant pays for that data does not have to be disclosed.
"Many comp consultant small-boutique firms who do not have their own comprehensive databases and have to get them, sometimes from multiple sources, from larger consulting firms," says
David Hirschmann, president of the Center for Capital Markets Competitiveness at the U.S. Chamber of Commerce in Washington.
"It would be neither useful nor helpful to an investor to understand the source of all of this data," he says.