The Dodd-Frank Act is set to shake up the financial regulatory system, but will it do enough?
‘The making of laws is like the making of sausages: the less you know about the process, the more you respect the results.’ The politician who said this sure knew what he was talking about – and despite lawmakers’ lofty promises to exact revenge on the forces that brought the economy to its knees, the crusade to overhaul the financial regulatory system has been pockmarked by partisan mudslinging, horse-trade politicking and aggressive lobbying.
Now, after more than a year of wrangling – and a little bare-knuckle brawling – the Democrats are readying their victory speeches in preparation for the (allegedly) imminent enactment of the 'Dodd-Frank Wall Street Reform and Consumer Protection Act.' As this issue of Corporate Secretary was going to press, the House had already approved the bill, and the Senate, which has claimed sufficient bipartisan support (read: three Republican voters) to ward off any filibuster attempts, had closed debate and scheduled a final vote.
The 2,316-page mountain of legislative sausage (which ironically amends the Paperwork Reduction Act) is a mish-mash of compromises – or ‘reconciliation’, in legislative parlance. As a result, both parties got what neither wanted. The Democrats, however, seem to have done a little better than their colleagues across the aisle. Senator Richard Shelby (Republican) slammed the bill as a ‘legislative monster’; for Senator Dodd it was merely ‘not a perfect bill’.
Indeed, claims that the new measure will kill bank bailouts or prevent a repeat of the 2008 market meltdown are dubious at best. The bill falls short of expectations, with too many provisions – or not enough – negotiated away in the name of bipartisanship. But the legislation is not a train wreck. Given the deluge of provisions issuers must now pore over, legal advice is in demand, and the favorite joke on Capitol Hill right now is that Congress has finally managed to pass a jobs bill: full employment for lawyers.
Just the beginning?
The most important point, despite the heated rhetoric, may well be that this is only the first step. As they say, the devil is in the detail, and according to Davis Polk & Wardwell’s estimation (see Estimates of rulemaking by agency, below), the bill promises to keep regulators busy enacting more than 240 rules and producing
nearly 90 reports and studies. ‘So this is the big open issue,’ says Steven Shapiro, general counsel and
corporate secretary at Cole Taylor Bank. ‘Most of the bill’s bite will come from the regulations and studies, and those haven’t been written yet.’
Two substantive provisions of the bill involve the creation of new regulatory bodies: the Financial Oversight Council (FOC) and the Consumer Financial Protection Bureau (CFPB). The 10-member FOC, chaired by the secretary of the Treasury, is tasked with monitoring the marketplace to identify and deal with emerging systemic risks.
The CFPB, known as the ‘consumer watchdog’, is one of the bill’s most hotly contested provisions. It will be led by a presidentially appointed director and granted authority (a good deal of authority, according to Shapiro) to govern financial institutions dealing in consumer products and services. For an issuer like Cole Taylor, this means another regulator to contend with; and although institutions with less than $10 billion should technically be outside the CFPB’s remits, Shapiro cautions against testing the technicality.
Of the pre-existing regulators, it looks like the Federal Reserve, the Commodity Futures Trading Commission (CFTC) and the SEC have all come out ahead in terms of expanded jurisdiction and beefed-up authority. A new power that has garnered much attention is the Fed’s ability to regulate interchange fees – which Shapiro says he’s happy about.
Another significant development, which was raised during a panel at the Society of Corporate Secretaries and Governance Professionals’ national conference in July, deals with enhanced whistleblower protections. As panel members noted, the SEC has essentially outsourced whistleblower hotlines, as employees can now call the commission directly without exploring internal avenues first.
Proxy access
Christmas may have come early for shareholders on the quest for proxy access. Considering the number of
proposed shake-ups, it is interesting that this issue stood out as one of the thorniest subjects of the debate. A last-minute proposal by Senator Dodd to increase the ownership threshold to 5 percent was tossed out,
leaving the SEC with the authority to pass proxy access rules as it sees fit. The SEC has indicated its intention to move forward with this – at press time a concept release with a 90-day comment period was imminent. The substantial change to the status quo this provision seems to make is eliminating the concern about
whether the SEC has the authority to sidestep state law and adopt proxy access rules.
One big surprise was the elimination of the majority vote provision, which seemed to garner little attention during the process. As David Huntington, partner in the capital markets and securities group at Paul, Weiss, Rifkind, Wharton & Garrison, points out, ‘Shareholders care about majority voting. This year it was among the most commonly filed proposals. Just because it’s not required doesn’t mean issuers can ignore it.’
On the executive compensation front, the majority of the provisions are unlikely to surprise anyone. There is one that seems to have some issuers in a bit of a panic, however: the so-called pay-parity disclosure. According to this provision, companies will now have to provide the ratio of the CEO’s salary to the median salary of all employees, as calculated without the CEO. ‘Personally, I’m unclear, from a disclosure perspective, what benefit can come from this,’ says Elizabeth Powers, a partner and executive committee member at Dewey & LeBoeuf. ‘I think people were a little surprised to see this. They were probably expecting something focused more on comparing the CEO’s pay to that of the other senior officers.’
Michael Melbinger, a partner in the executive compensation practice at Winston & Strawn, echoes Powers’ sentiments, adding: ‘The pay-parity disclosure will create an incredible new burden. This information does not exist anywhere today.’
Another issue here, as Irv Becker, national practice leader of executive compensation at Hay Group, points out, is the potential effect on now-required say-on-pay votes. ‘It could be that some of the institutional investors will start saying they don’t want to see CEO pay above a certain multiple over median pay, which I think will create some headaches for companies,’ Becker says. ‘Administratively, pay-parity sounds likes it’s going to be a nightmare for companies.’
The say-on-pay problem
Few will be surprised by the inclusion of say on pay in the final version. Although the advisory vote may seem benign, Becker notes that ‘one of the things that has happened in the UK with say on pay is that, to avoid controversy, many compensation committees have moved to the middle ground on pay design; but if every company’s compensation program looks exactly the same, how do you differentiate your company from your competitors in terms of attracting talent?’ He suggests that this may be a future challenge for issuers in the US as well. ‘How do you maintain the uniqueness of your pay package, and how do you explain and rationalize it in the compensation discussion and analysis?’ he asks.
One small surprise may be the option for companies, subject to shareholder approval, to adopt say-on-pay votes every two or three years, instead of annually. Convincing shareholders to move to a biennial or triennial occurrence may be tricky. On this front, Rhonda Brauer, managing director in the corporate governance division of Georgeson, offered advice to attendees at the Society’s July conference: raise this question now with institutional investors, and ask, ‘What would RiskMetrics do?’ She predicted that the proxy advisory firm would evaluate these proposals on a case-by-case basis. ‘If a company has good pay practices,’ she said, ‘RiskMetrics may be OK with say-on-pay votes every two or three years.’ At the same conference, Peggy Foran, Prudential Financial’s chief governance officer and corporate secretary, recommended sending letters to the top 50 investors to get their feelings on the issue.
Open questions
One thing Powers suggests for those who are drafting proposals for votes every two or three years is to go back and re-read the provisions themselves. She warns that ‘the language is a little unclear and has caused a bit of confusion – not in terms of meaning, but in how the actual mechanics are to operate.’
A minor detail, but one that Powers’ firm is flagging for clients, is the elimination of the broker discretionary vote on executive compensation matters. ‘Broker non-vote matters were always in the purview of the NYSE, but it looks like a growing pattern,’ she says. ‘It’s not entirely clear exactly what the scope of the term ‘executive compensation’ is. Does it just encompass the shareholder votes referred to in the bill – say on pay and golden parachutes – or is it broader?’
Although the effects of these provisions may not be felt for a while, experts predict they will increase the importance of regular shareholder communication. ‘It’s the general theme that runs through most of these provisions,’ Huntington says. ‘Companies are going to have to be able to articulate business plans, compensation structures, long-term goals, director nominees and the like to their investors in a clear and comprehensible fashion.’
So what should governance professionals be adding to their summer workload? ‘Start with the easy ones,’ is Powers’ advice. ‘Check out your compensation committee and make sure it meets the existing standards in terms of independence.’ She also suggests putting a hedging policy in place and hammering out the clawback policy sooner rather than later. After that, she says, ‘all you can do is wait to see what the regulators sort out.’
