Editor: Mr. Rodriguez, would you tell our readers something about your professional experience?
Rodriguez: I practice in the area of tax-sensitive transactions, with a focus on executive compensation and related corporate governance matters. I am a partner at the New York office of Day Pitney, which was formed by the merger a year ago of Day Berry & Howard and Pitney Hardin. We have about 400 lawyers in offices from Boston to Washington, D.C. The combination resulted in one of the strongest executive compensation and employee benefits practices in the Northeast, which is, of course, of particular interest to me.
My interest in tax-sensitive transactions goes back to my undergraduate days at Harvard College, where I wrote my thesis on a tax subject. That interest continued through law school, also at Harvard, where I undertook tax projects for the U.S. Treasury Department and worked for a tax professor. In private practice, I have focused in recent years on how management teams are incentivized and how compensation impacts the interests of the various stakeholders in an enterprise and its governance processes.
Editor: In looking at a couple of recent proxy statements, I have been astonished at the disclosure requirements regarding executive compensation. Doesn't so much information serve to confuse rather than enlighten the reader?
Rodriguez: To be sure, some disclosure has been excessive without shedding much light. Striking a proper balance should be a principal goal here, which has eluded some.
I believe that meaningful disclosure about compensation practices is vital. One might argue too much disclosure serves to obfuscate rather than to illuminate. But disclosure in each of the major categories that you now find in proxy statements is important. Recent disclosure requirements have brought about a focus on the reasons behind compensation initiatives, and this has encouraged keeping an eye on total compensation, which is valuable. The disclosure rules are intended to allow for meaningful comparisons across industry segments, and while the SEC's interpretation of the rules may fall a little short of the mark, the resulting disclosure has shed increased light on the subject for both compensation committee members and enlightened shareholders.
Good disclosure must address all elements of compensation, including options, performance shares, restricted stock and other long-term incentives, timing of grants, qualified and non-qualified retirement and income deferral arrangements, and salary and bonus arrangements, as well as entitlement to severance and change-in-control payments. But to meet the rules, the disclosure must shed light on the reasons behind these arrangements and the reasons for particular compensation decisions for senior executives. In short, the focus is on the how and the why of total compensation. For good measure, there is increased disclosure on director compensation as well.
Editor: What was behind the SEC's adoption, in July of 2006, of new compensation disclosure rules for the 2007 proxy season?
Rodriguez: The spotlight on extreme abuses and excesses has sometimes led to government regulation that is overly burdensome. Compensation has received particular scrutiny in this regard. Certainly, Enron, WorldCom, Tyco and other corporate scandals focused attention on corporate governance generally including compensation decision-making. The Disney and NYSE cases in particular focused attention on the compensation committee. In the wake of those cases, companies began to address compensation process, but unfortunately meaningful disclosure lagged internal changes. The SEC tried to jawbone improved disclosure with a series of speeches on the subject, but disclosure continued routine. Justifiably dissatisfied with voluntary compliance, in 2006 the SEC issued a massive set of new rules on compensation disclosure. The new rules are imperfect, and, indeed, some of the SEC's interpretations appear contrary to the agency's stated objective, but in general increased disclosure and the emphasis on process and what the SEC refers to as ' principles based disclosure' is serving to sharpen compensation decision-making and present largely more useful public disclosure.
Editor: How about H.R. 1257, on (a) an annual nonbinding shareholder vote on a company's executive compensation plan and (b) a nonbinding advisory vote if the company awards a new golden parachute package while simultaneously negotiating the purchase of sale of the company?
Rodriguez: The proponents of this legislation emphasize that the shareholder vote is nonbinding. They appear to be reacting to the excessive pay some senior executives have managed to garner in connection with their departures. The proponents also point out that the SEC should be given the authority to compel such a vote. In my judgment, compensation decisions should be made in a deliberate process by a compensation committee, and I see little benefit in a formal shareholder advisory vote. At the moment H.R. 1257 has passed the House but has not been acted on in the Senate.
Editor: Do you think Congress will enact this or similar legislation in the future?
Rodriguez: I would hope that Congress would exercise some restraint in enacting palliatives that are politically popular but create an unnecessary burden and distraction. My recommendation would be to let the new disclosure rules wash over the market for a couple of years and then assess if additional reform is necessary. But I cannot predict how Congress will act, especially in an election year.
Editor: What about the basic reality that it is the CEO who usually has the final word in selecting board members, including those who will serve on the board's compensation committee?
Rodriguez: The question presumes, incorrectly I believe, that senior management at our public companies, including the CEO, orchestrates who is going to be on the board in order to maximize their compensation. There is an increased emphasis today on the independence of board members. The New York Stock Exchange and other rule-makers have now promulgated roadmaps for determining independence. A trend toward allowing shareholders a greater say in the process of electing directors is gaining momentum, and I think this is more useful than allowing them to micromanage executive compensation decisions.
Editor: If director liability is on the increase as a consequence of the renewed scrutiny on executive compensation, won't this have a dampening effect on companies' ability to recruit people for the board of directors and the board's compensation committee?
Rodriguez: Increased liability resulting from the changed climate of recent years is certainly a risk for directors generally and for CEOs and CFOs. I do not think that the liability that attaches to compensation committee membership compares unfavorably with that of audit committee members, however. And I have not seen it as an issue in recruiting good board members, at least in connection with executive compensation matters. The SEC's Compensation Discussion and Analysis, or CD&A, is now filed, which creates increased liability for the company, but the formal compensation committee report itself is now very limited.
I believe that the key to avoiding director liability is doing a good job and that today means having the right process in place. If that process is in place and adhered to, actual decisions are rarely going to be subject to challenge. In addition, education on compensation matters is important, and a company that spends time on educating its directors in this area is less likely to be a target for criticism.
Editor: You mention process. Has this new focus on process intruded on the board's role of providing strategic oversight of the business? In other words, has process trumped substance so far as the board of directors is concerned?
Rodriguez: No, quite the contrary, I believe. What process is trying to do is prevent the board from acting as a rubber stamp or in an arbitrary manner. Clearly, focusing on corporate strategy is a key responsibility for the board. With respect to the audit and compensation committees, it is essential that committee decisions fit within the overall strategy approved by the board as a whole. I believe that the emphasis on process ensures that the directors are adequately equipped to make those decisions. The best way to make sure the process is functioning is to shed light on the how of the decision.
Editor: How do you see - or do you see? - the role of the board's compensation committee evolving over the next couple of years?
Rodriguez: As noted, there will be a continued emphasis on process, which will include seeking out expert advice and deliberating carefully on that advice. Since the promulgation of the new rules, the question behind every compensation decision is now always " How is this going to look in the CD&A? ". That may have the effect of keeping some directors away from innovation, which is not necessarily a good thing, but it should also pave the way for a new set of best practices to emerge. And the SEC's emphasis on ' principles based disclosure ' over the boilerplate of the past need not squelch innovation.
Editor: Where does the board compensation committee look for the best possible advice?
Rodriguez: Over time there has been increasing reliance on independent advisors and consultants. The principal issue here, I think, is independence : if the advisor or consultant is providing other services to the company, the question that needs to be considered is whether the advisor is truly independent. Also important is getting the right mix of directors on the compensation committee. The committee needs to be well trained and include one or more members who have a good understanding of compensation in addition to good business sense.
Editor: There has been considerable discussion concerning performance targets. Many companies are reluctant to disclose the performance targets they use in establishing executive compensation. As a three-way discussion among the SEC, the investment community and the public company community, how is this proceeding?
Rodriguez: This issue is being actively pursued at this moment. The SEC has sent letters to select companies across a range of industries critiquing their proxy compensation disclosure. A recurring theme in letters received by our clients, and we understand by issuers generally, is the paucity of disclosure of performance targets. Companies are justifiably reluctant to reveal confidential or competitive information. Long-range compensation, where stock performance or some fairly broad targets are incorporated, is generally not the concern. It is disclosure of short-term performance targets, which can often reveal competitive information, that is giving people pause.
I believe this issue will play itself out over the next two proxy seasons. I think new standards will emerge, but the risk is that compensation committees may shun some meaningful performance objectives for fear of later being required to disclose potentially competitive information. I am hopeful that the SEC will provide great latitude in permitting companies to restrict disclosure of strategic performance targets.
Editor: Is there anything you would like to add?
Rodriguez: Yes. To be complete I would like to note the brooding presence in disclosure of Congress' penchant for using tax law to attempt to mold compensation behavior. The Internal Revenue Code is too blunt an instrument to hone compensation practices and often does not accomplish much more than full employment for lawyers and revenue to the fisc at the expense of shareholders. The most recent example is 409(a), which addresses deferred compensation arrangements broadly defined. Previous examples that still plague compensation committees are 280G, the "golden parachute" rules, and 162(m), which denies a deduction for non-performance based compensation over a million dollars. The tax law has been ineffective in addressing perceived cases of excessive compensation. Unfortunately, once these rules become law and begin to raise revenue, there is no constituency to push Congress to repeal or significantly amend them, even where it is clear that the intended results have not been achieved.