On December 16, 2009 by a 4-1 vote, the SEC adopted new rules mandating increased disclosure about a public company’s compensation, corporate governance and risk policies. The new rules have an effective date of February 28, 2010 with changes to financial reporting applying for fiscal years ending on or after December 20, 2009.

Over the next few months, we will provide Action Steps that should be taken for effective management of executive and Board compensation practices in concert with the new “rules of the road”.

Action Step 1- Own the Process

The executive team plays a crucial role in communicating the company’s business strategy and challenges to both the Board of Directors and the employees. They should also consistently implement and communicate their Compensation Philosophy which enhances trust and shared values to the Board and employee base. Although many organizations do a decent job of communicating their business goals & objectives—–there is often a decrease of effectiveness of company leadership effectively and consistently communicating their philosophy on compensation.

The use of compensation consultants has attracted significant attention recently. Many Board compensation committees use the same consultant that the management team uses, while several others opt to select their own consultant in addition to the one used by management. In the new rules enacted by the SEC, public organizations will need to identify any compensation consultant that provides counsel in excess of $120K per year in the company financial statements.  This new ruling creates a conflict-of-interest scenario when the executive consultant retained by a compensation committee is part of a larger human resources consultancy that derives significant revenue from work for company management.

External advisors such as compensation consultants and legal counsel are essential to the increasingly complex work of compensation committees. We recommend that compensation committees take an “ownership” role in the selection of these advisors as opposed to them being selected by executive management. Advisors should clearly understand that they receive their assignments from and report to the committee. In addition to advising on technical compensation issues, consultants and legal advisors who are experts on compensation matters can assist committees to ensure that all relevant issues are raised and improve the way the committees operates. It is also important to remember that simply doing project work for management does not automatically disqualify a consultant from working on executive compensation. But the committee needs to be aware of and approve other work in which the consultant engages.

Key Summary Recommendations

  • Board compensation committees should assert control over the executive compensation process, but give management a voice.
  • Ensure all outside advisors doing work for the committee are selected by and report to the compensation committee or the full Board.
  • Share a single consultant with management, as long as the committee controls the relationship.
  • Do not automatically disqualify the executive compensation consultants from working for the compensation committee just because they are doing project work for management.