Executive Compensation, the Delaware Model and a Proposed Solution (Part 5)

We have proposed a solution to the executive compensation problem. It entails an amendment to Section 13 of the Exchange Act to prohibit the payment of excessive compensation. The provision defines excessive and contains a safe harbor that requires the board to implement meaningful procedures for ensuring the integrity of the executive compensation approval process.

We are discussing the proposed safe harbor that would allow boards to meet the requirements of the provision through process.  Part of the process would require that only independent directors serve on the compensation committee.  The definition of independent would be strict and seek to eliminate many of the loopholes currently in the rules of the stock exchanges or the holdings of the Delaware courts.  It would also provide that shareholder nominated directors would be presumed independent, providing companies with an incentive to accept shareholder nominated directors.

In addition, however, the process would need to be fair.  The safe harbor, therefore, gives the compensation committee its own authority to determine funding.  This concept is taken from SOX.  Sarbanes Oxley provided that the audit committee should determine its own financing.

Likewise, the provision provides that the compensation committee can hire consultants and advisors but that they must be independent of the company, with independence defined as no other material financial relationship with the company except for the work done for the compensation committee.  Currently, there is no requirement that compensation consultants not have a significant financial relationship with the company and some evidence that this is not an uncommon practice.

Finally, the proposed rule ends with express rulemaking authority on the part of the Commission.  The Commission would, therefore, have the authority to provide objective guidance on what the terms mean.

This proposed amendment to Section 13 of the Exchange Act would not solve all problems in the compensation area but it would have a sedating affect on compensation.  Moreover, by removing matters from Delaware and giving enforcement authority to the SEC, there would likely be more meaningful criteria that developed over time.  This sort of provision is overdue.