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Compensation Control: Dodd-Frank Wall Street Reform Act Presents Significant Business Planning Issues

In response to the recent Wall Street meltdown, and various abuses perceived to be caused by compensation systems that encourage undue risk taking, Congress enacted the Dodd-Frank Wall Street Reform Act (the “Dodd-Frank Act”) in July of 2010.  The Dodd-Frank Act is considered the most significant legislation in the area of compensation controls on public companies and financial institutions since Sarbanes-Oxley in 2002.   At its core, the Dodd-Frank Act requires expanded reporting obligations for public companies and financial institutions to allow activist stockholders to respond appropriately.  The Dodd-Frank Act becomes fully effective in 2011 and the planning required for public companies, financial institutions, and their advisors will be significant.

Below is a summary of certain of the significant controls on compensation established by the Dodd-Frank Act.

  • Say-on-Pay Vote.  Proxy statements must now include a non-binding vote to approve executive compensation.  Corporate boards that do not respond to stockholder disapproval of compensation programs will likely face activist stockholder pressure on their own tenure.
  • Compensation Clawbacks.  Companies are required to adopt policies to recoup from executive officers any incentive compensation paid during a 3-year look-back period, if the company was required to restate earnings due to material non-compliance with financial reporting requirements.  The executive officer must pay back the excess compensation even if the executive officer was not involved in any misconduct.
  • Compensation Committee Independence.  Compensation committees must be independent and must be given the authority to select consultants, counsel and other advisors.
  • CEO Compensation Disclosure.  The proxy statement must report the ratio of median employee total annual compensation to that of the CEO.  This percentage will become significant in future years since activist stockholders will be able to compare one company’s ratio against its peer group’s ratio.
  • Pay-for-Performance Disclosure.  The proxy statement must set forth the relationship between executive compensation actually paid and financial performance.