Now that Congress has passed the financial regulatory reform bill with the Senate’s 60-39 vote on Thursday [See July 15 Reuters article here.], the hard work begins not only for regulators but for public companies who will try to make sense of it all.
Many boards and senior management will be looking to their counsel and outside consultants for advice on how to prepare for these changes, most of which will most likely occur in time for the 2011 proxy season. That is why I have prepared a short version of Worth Reading on some thought leadership on financial reform that doesn’t include the politicians. I found the literature both enlightening and resourceful.
Who knows? Maybe some of what was discussed by the Squam Lake Working Group on Financial Regulation and presented by the newly formed Ethics Metrics LLC may be used by regulators as they draw up the new rules.
As a reminder, here is a rundown of the corporate governance measures in the final bill that is due to be signed by President Barack Obama next week [To see the whole bill, click here.] The bill would:
• Give shareholders an advisory vote on executive pay
• Give shareholders proxy access to nominate directors
• Require companies to disclose chair and CEO structure
• Establish standards calling for independent compensation consultant
• Establish clawback language for executive compensation based on inaccurate financial statements.
The following are listing standards of the major stock markets that would be required under the legislation and what the SEC must sign off on:
• All compensation committee members must be independent (already required by some)
• New SEC rules must define “independence” based on consulting and advisory fees and whether a director is affiliated with a company
• Compensation committees would be authorized to hire and oversee independent compensation consultants and legal counsel (similar to auditor/audit committee model)
• All public companies would have to impose clawback rules for all current and former executives when a material restatement is made.
Here are the white papers produced by the Squam Lake Working Group (this group also published a book The Squam Lake Report: Fixing the Financial System available on Princeton University Press and Amazon.com and EthicsMetrics on financial reform that I think are Worth Reading:
• Regulation of Executive Compensation in Financial Services, Squam Lake Working Group on Financial Regulation through the Maurice R. Greenberg Center for Geoeconomic Studies at the Council on Foreign Relations, February 2010. Summary: Many people argue that inappropriate compensation policies in financial companies contributed to the global financial crisis. Some say the overall level of pay was too high. Others criticize the structure of pay, claiming that contracts for CEOs, traders, and other professionals induced them to pursue excessively risky and short-term strategies. This Working Paper argues that governments should generally not regulate the level of executive compensation at financial firms. Instead, a fraction of compensation should be held back for several years to reduce employees’ incentives to take excessive risk.
• A Systemic Regulator for Financial Markets, Squam Lake Working Group on Financial Regulation through the Greenberg Center for Geoeconomic Studies at the Council on Foreign Relations, May 2009. Summary: Financial regulations in almost all countries are designed to ensure the soundness of individual institutions, principally commercial banks, against the risk of loss on their assets. This focus on individual firms ignores critical interactions between institutions. Attempts by individual banks to remain solvent in a crisis, for example, can undermine the stability of the system as a whole. The focus on individual institutions can also cause regulators to overlook important changes in the overall financial system. The solution to this narrow institutional focus is simple: One regulatory organization in each country should be responsible for overseeing the health and stability of the overall financial system. The group argues that the central bank should be charged with this important new responsibility.
• A New Information Infrastructure for Financial Markets, Squam Lake Working Group on Financial Regulation through the Greenberg Center for Geoeconomic Studies at the Council on Foreign Relations, February 2009. Summary: Information about prices and quantities of assets lies at the heart of well-functioning capital markets. In the current financial crisis, it has become clear that many important actors — both firms and regulatory agencies — have not had sufficient information. The group proposes a new regulatory regime for gathering and disseminating financial market information. Government regulators need a new infrastructure to collect and analyze adequate information from large (systemically important) financial institutions. This new information framework would bolster the government's ability to foresee, contain, and, ideally, prevent disruptions to the overall financial services industry.
• Impact of Ethics, Governance, and Systemic Risks on Investment Values: 2002 through 2009 and Beyond, Ethics Metrics LLC, June 29, 2010. Summary: In order to restore ethics and integrity to the financial system, Ethics Metrics believes the following actions need to be taken: bring transparency and accountability to boards of financial holding companies and their related compliance gatekeepers; enable accurate valuations of financial holding companies’ earnings, equity and bond values and credit default swap prices by factoring in degrees of compliance; measure and rate exposure to systemic risk from 2002-2009; foster new shareholder communication between financial holding companies and shareholders with respect to 10 ethics, governance and systemic risks issues; integrate regulatory governance risks into risk/return models; and empower boards of financial holding companies and management investment companies to act and invest ethically.
Gary Larkin is a research associate in the corporate leadership department at The Conference Board in New York. His research focuses on corporate governance, including succession planning, board compo…