Senate Chews Through Amendments to Dodd Bill

Anyone in the corporate governance world wondering when Congress will move forward with its massive reform of financial regulation will need to keep waiting.

Senate leaders had hoped last week to pass the 1,400-page regulatory reform bill sponsored by Senate Banking Committee Chairman Christopher Dodd, but instead spent most of their time wading through hundreds of amendments proposed by other senators. The amendments that did pass mostly pertained to issues such as managing systemic risk to the financial system, the role of the Federal Reserve, and oversight of trading in derivatives. Amendments most relevant to corporate governance are still waiting in line.

Turner

With debate now transpiring on the Senate floor rather than in committee (which is the usual practice), “it’s like a shoot-out at the OK Corral,” says Lynn Turner, a former chief accountant at the Securities and Exchange Commission who is now managing director at LECG. “Nobody knows how it will come out.”

The original Dodd bill included many reforms governance enthusiasts would love: shareholder advisory votes on executive pay, shareholder access to the proxy statement, a requirement that all members of a corporate board’s compensation committee be independent, and more. The bill is also notable for what it did not include: a provision to exempt small public companies from compliance with Section 404(b) of the Sarbanes-Oxley Act, which requires external auditors to attest to a company’s internal controls over financial reporting. A financial reform bill passed by the House in December does include a 404(b) exemption, and bridging that gap will be one of the most important compliance-related questions in the final legislation.

Senate Banking Committee spokesmen now say deliberations on the bill’s many amendments will resume this week. Dodd has also warned that the flood of amendments may overwhelm the bill completely, although the idea that Democrats will actually let regulatory reform collapse into failure seems unlikely.

Nevertheless, scores of amendments still seek to pull the Dodd bill in many different directions.

Sens. Kay Bailey Hutchison (R-Texas) and Mary Landrieu (D-La.) have filed one amendment to exempt all companies with less than $150 million in market capitalization from Section 404(b). That would actually repeal SOX 404(b) compliance for some small companies, since the current compliance threshold is a market cap above $75 million—those companies have had to comply with SOX 404(b) since 2004. Companies with market caps below $75 million have won repeated deadline extensions from the SEC, although that is currently set to expire on June 15.

A separate amendment filed by Sen. David Vitter (R-La.) would set the exemption at $75 million, in step with current practice and the 404(b) exemption included in the House bill.

Both amendments also call for additional cost-benefit studies of Section 404 compliance. The Hutchison amendment calls for a study of how to reduce the compliance burden for companies with public float of $150 million to $700 million, including recommendations about whether the exemption should be extended to larger issuers. The Vitter amendment, like the House bill, calls for a study to determine how to reduce the compliance burden for companies with market caps from $75 million to $250 million, and whether doing so would encourage companies to list on U.S. exchanges.

“Proxy access language and majority voting are fundamental to basic shareholder rights. Those have to be part of the reform. Everything else is secondary.”

—Jeff Mahoney,

General Counsel,

Council of Institutional Investors

However these Section 404(b) amendments fare, all public companies must still comply with Section 404(a), which requires senior executives to say whether or not internal controls are effective. Nothing in the legislation proposes changing that.

Other Items of Business

Delaware Democrat Thomas Carper has filed two amendments that would strip out the bill’s major corporate governance provisions. One would delete language that reaffirms the SEC’s authority to write rules permitting shareholders to place nominations for directors into the proxy statement; the other strikes a provision that would require director nominees in uncontested board elections to get a majority of votes cast before they can be seated.

Shareholder activists view proxy access as the Holy Grail of corporate governance. Companies and business groups such as the U.S. Chamber of Commerce and the Business Roundtable, however, vehemently oppose it and have threatened litigation as soon as the SEC publishes any rules to that effect. The Dodd bill is an attempt to thwart that litigation, and Carper’s amendments seek to undo that protection. Carper, from Delaware, is also playing to supporters of Delaware corporate law, a vital interest group in his state.

Majority-vote thresholds for director elections are a less pressing concern. Dozens of companies (including giants such as Pfizer and Intel, have adopted majority voting voluntarily), but a plurality threshold, where a director can theoretically be elected with just one affirmative vote, is still the standard. If the measure fails in Congress, an SEC Investor Advisory Committee is likely to recommend that the SEC require majority voting anyway.

COMMENT LETTERS

The following excerpts are from three separate letters sent to the Senate regarding the SOX amendments:

We believe that interim and annual audited financial statements provide investors and companies with information that is vital to making investment and business decisions. The accounting standards underlying such financial statements derive their legitimacy from the confidence that they are established, interpreted and, when necessary, modified based on independent, objective considerations that focus on the needs and demands of investors—the primary users of financial statements. We believe that in order for investors, businesses and other users to maintain this confidence, the process by which accounting standards are developed must be free—both in fact and appearance—of outside influences that inappropriately benefit any particular participant or group of participants in the financial reporting system to the detriment of investors, businesses

and capital markets. We believe political influences that dictate one particular outcome for an accounting standard without the benefit of a public due process that considers the views of investors and other stakeholders would have adverse impacts on investor confidence and the quality of financial reporting, which are of critical importance to the successful operation of the U.S. capital markets.

—Center for Audit Quality; CFA Institute; FEI; AICPA; Council of Institutional Investors; U.S. Chamber of Commerce; Investment Company Institute

Proxy access rules promulgated by the SEC could exacerbate the short-term focus that is widely considered to be a contributing factor to the financial

crisis. The prospect of frequent election contests could cause directors to

focus on short-term stock price rather than investments for the creation of long-term value. It also would allow special interest groups to exert undue

influence and pursue short-term goals to the detriment of other

shareholders. This is already evident in the practices of some hedge funds, which have

encouraged companies to engage in practices such as demanding overleveraging,

increased dividends and reduced capital expenses that increase immediate

financial

returns to shareholders but may be harmful to longer-term growth.

We strongly and unequivocally oppose Section 972 of the Restoring American Financial

Stability Act, and we urge you to vote “yes” on the Carper

amendment to

strike the

section.

—Business Roundtable

As you know, the House of Representatives passed H.R. 4173, Wall Street Reform and

Consumer Protection Act of 2009, which includes a provision to permanently exempt smaller companies from Section 404(b). In fact, 101 Democrats voted with their Republican colleagues against an amendment to strip this job creation language from the bill on the House floor. Although there have been arguments made to exempt companies with public floats of up to $700 million, we believe that given the data from the SEC study and the recent lackluster level of IPOs, the exemption should include companies with public floats of at least $150 million.

A continuation of the endeavor to permanently exempt smaller companies from Section 404(b) should be sustained in S. 3217, “Restoring American Financial Stability Act of 2010.” For this reason, we ask for your support of smaller public companies as the Senate considers its version of financial regulatory reform legislation.

—NYSE, NASDAQ, etc.

“We think it’s critical that Sections 971 and 972 stay in the bill,” says Jeff Mahoney, general counsel for the Council of Institutional Investors. “Proxy access language and majority voting are fundamental to basic shareholder rights. Those have to be part of the reform. Everything else is secondary.”

An amendment filed by Sen. Sherrod Brown, D-Ohio, would require companies to report more information about the debts they carry by disclosing that information in SEC filings. In a somewhat unusual alignment of political bedfellows, a group of seven investor, financial, and accounting associations last week published a letter opposing that idea—not so much because of the amendment’s disclosure goals, but rather because it puts Congress in the position of making accounting rules. Such actions, they said, should be left to the Financial Accounting Standards Board, which sets accounting standards in the United States.

The Senate bill currently includes several other corporate governance reforms and measures that would affect public companies. For instance, it would require public companies to provide for an annual shareholder advisory vote, or say-on-pay. Such votes are already required for the several hundred banks and other businesses that took government bailout money in 2009, and a few dozen corporations have already offered say-on-pay voluntarily. The House bill gives shareholders advisory votes on pay practices including executive compensation and golden parachutes.

The Senate bill also allows the SEC to become self-funded through fees, penalties, and other assessments imposed on registrants—something SEC Commissioners and some lawmakers have been clamoring for. That measure wasn’t in the House bill, which instead would double the SEC’s budget within five years.

And both bills include provisions to create an SEC whistleblower reward program to provide rewards of up to 30 percent of the funds recovered by people who report information that uncovers securities fraud.

Still, Turner says the legislation is unlikely to have the intended effect of preventing some future financial crisis. “There are some small steps in the right direction,” he says, “but the greater part of the bill won’t fix the fundamental problem we have, and doesn’t do anything to hold banking regulators’ feet to the fire.”