October 18, 2010
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Reform Act) passed by Democratic majorities in the House and Senate, and signed by President Obama was primarily aimed at reigning in some of the worst excesses in the banking and securities industry. But a number of provisions in the Reform Act affect nearly all publicly traded companies, not just banks and hedge funds.
One important issue that affects companies traded on the NYSE and Nasdaq is commonly referred to as say-on-pay. Under this rule, companies must provide shareholders with the right to cast a non-binding vote approving executive pay and compensation. Now, a non-binding vote on compensation is fairly weak to begin with, and shareholders are often willing to support excessive pay as long as risky bets are paying off. But at least the new say-on-pay rules are an improvement over previous law governing executive compensation decision making.
Apart from the obvious weaknesses of the say-on-pay provision under the Reform Act, and the basic premise that the owners of a company ought to have a say on what the top executives will be paid, there are important systemic reasons to support say-on-pay provisions. Say-on-pay rules should add to greater financial stability, because it helps to limit the Wall Street bonus culture, in which executives are awarded bonuses equal to four or five times their base salary for finding clever (and usually risky) ways to achieve short-term boosts to share prices. The bonus culture rewards risky behavior and big bets, which add to financial sector and share price volatility and exacerbate systemic risk. The bonus culture has meant massive payoffs to executives if things go well, but there have been no consequences when things go badlyparticularly when they go badly at some time in the future. Say-on-pay gives shareholders a bit more say, albeit indirectly, in how much risk they wish to expose themselves to as owners of publicly traded companies.
Besides helping to maintain financial stability, say-on-pay also addresses, even though modestly, questions of economic justice and conflicts of interest. When CEOs get to pick their Boards of Directors, who in turn set the CEOs compensation package absent any real accountability or transparency, enormous pay has been the result. As Wall Street hotshots paid themselves enormous salaries and bonuses, it set up an aspirational standard for astronomical compensation in other industries as well. And as a system, it has helped to drive income and wealth inequality to outrageous and unhealthy levels.
The Reform Act requires companies to provide shareholders with the right to approve executive pay, which must be disclosed in proxy statements. Shareholders must be given the right to vote at least once every three years on executive compensation issues. Because it is non-binding, a vote by shareholders may not overrule decisions of the companys Board of Directors, but neither does it preclude shareholders from making compensation-related proposals for inclusion in proxy statements.
The vast majority of investors in U.S. companies hold their shares in street name — that is, in customer accounts with a securities intermediary, which is usually a broker or bank. To vote their shares, these investors, also known as beneficial owners, typically give voting instructions to their securities intermediary or to a third party (proxy service provider) retained by the broker or bank to receive voting instructions on its behalf. The securities intermediary must reflect the beneficial owners voting instructions when executing its proxy for shares held in customer accounts. The Reform Act requires all institutional investment managers to report at least annually on how they voted on any say-on-pay matter, and disallows banks and fund managers from casting discretionary votes on say-on-pay proposals.
The U.S. Chamber of Commerce, the Business Roundtable, and other corporate special interest groups are lobbying hard to for changes that will protect exorbitant CEO pay by giving corporations more control over the proxy voting system.
The Chamber is arguing that banks and Wall Street brokers should be allowed discretionary voting on behalf of shareholders – knowing the bankers and brokers will almost always rubber-stamp CEO pay recommendations from hand-picked Boards of Directors and Compensation Committees. The Chamber wants to allow brokers and banks to vote using preexisting instructions, on behalf of their clients, removing from shareholders the ability to obtain independent recommendations from proxy advisory firms. Such a rule change would permit banks and brokers to vote for management against the preferences of shareholders.
Meanwhile, the Business Roundtable has formed a Shareholder Communications Coalition that wants to give companies more control over shareholder communications by eliminating the rules that help protect shareholders privacy. Such a rule change would expose shareholders to proxy solicitations by management seeking their vote.
I urge the SEC to consider the interests of shareholders before making any changes to the existing proxy system that generally works well. Any rule changes must protect the voting preferences and privacy interests of shareholders, and must create a level playing field for proxy communications by shareholders and corporate management. The SEC, in the interest of financial stability, and corporate accountability transparency, must put the interests of ordinary shareholders before the interests of corporate executives and Wall Street bankers with exorbitant compensation packages which they are seeking to protect by lobbying for technical changes while nobody is paying attention.