DODD-FRANKS, THE SEC AND EXECUTIVE COMPENSATION

Prior articles have reviewed the provisions of Dodd-Frank which focus on SEC Enforcement (here) and rule making (here). Other provisions of the Act impact the Commission’s authority regarding executive compensation. In part, these are discussed by Chairman Schapiro in her remarks at the Center for Capital Markets Competitiveness on July 27, 2010, available here. The provisions regarding executive compensation include:

• Listed companies must have an independent compensation committee. The Act requires the SEC to issue rules directing national securities exchanges and associations to require all member of a listed company’s compensation committee to be independent. While there are current standards which address this question the new rules could be more stringent than existing standards. (See generally Thomas O. Gorman, “Critical Issues in the Sarbanes-Oxley Act: Audit Committee” (Sept. 2009) available at the SECActions articles section here). The SEC rules must be issued within one year of enactment.

• The SEC will also issue rules within one year of enactment regarding the independence of any advisor or consultant to the compensation committee. The committee, in its sole discretion, is authorized to engage consultants, legal counsel and other necessary advisors in a manner which is reminiscent of the authority given to the audit committee under The Sarbanes-Oxley Act. The committee is responsible for the work of the consultants.

• There are five additional key provisions regarding compensation:

1) The Commission is required to write rules requiring the disclosure of the relationship between executive compensation actually paid and the performance of the company;

2) Other rules must be issued requiring the disclosure of the median compensation (except that of the CEO), the annual total compensation of the CEO and the ratio of the medial compensation to that of the CEO;

3) At least once every three years shareholders at a meeting must be given the opportunity to have a non-binding vote on executive compensation while every six years they can determine if the vote should be every one, two or three years;

4) In any proxy or consent solicitation for the approval of an M&A transaction, shareholders must be given a non-binding vote on golden parachutes; and

5) The SEC must require listing exchanges to enforce policies requiring the disclosure of incentive based compensation and clawback policies.

The SEC is also required to write rules requiring companies to disclose if directors and employees are permitted to hedge the value of equity securities.

There are additional provisions regarding executive compensation at financial institutions. Generally, they require that rules be written regarding executive compensation based on arrangements which will not encourage excessive risk taking. Federal regulators include the SEC, the Federal Reserve, the OCC, the FDIC, the OTC, the National Credit Union Administration Board and the Federal Housing Finance Agency.

THE SEC SETTLES ITS NEW CENTURY SUB-PRIME CASE

New Century Financial was once the number three sub-prime lender. The Commission’s action against its three officers is one of the more significant market crisis cases brought by the SEC to date. On Friday, the agency settled with each defendant obtaining the relief sought in the complaint. SEC v. Morrice, Civil Action No. CV 09-01426 (C.D. Cal. Filed Dec. 7, 2009).

The New Century case was brought against Brad Morrice, former CEO and co-founder, Patti Dodge, former CFO and David Kenneally, former controller as discussed here. The complaint is similar to the one filed against the former executives of the number one sub-prime lender, Countrywide Financial (here). The claims center a disclosure fraud keyed to what defendants Morrice and Dodge failed to tell investors about the loan portfolio of the company.

New Century, which was a REIT, originated and purchased loans through two divisions. Although its lending centered on the sub-prime market, the company played down the risks in its filings. This trend continued even as the sub-prime market was unraveling and the company suffered a liquidity crisis which was not disclosed to investors.

As the liquidity crisis unfolded during the second and third quarters of 2006, accounting manipulations began. Ms. Dodge and Mr. Kenneally improperly made significant reductions to the reserves to inflate revenue. As the reserves were reduced, the demand for loan repurchases dramatically increased. This left the reserves for those repurchases significantly understated. Inflated revenues yielded an artificial share price.

To settle, Mr. Morrice consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 13(b)(5) as well as from aiding and abetting violations of Section 13(a). He also agreed to disgorge $464,364 plus prejudgments interest, to pay a civil penalty of $250,000 and to a five year officer-director bar.

Ms. Dodge settled with the SEC on similar terms. She consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(b)(5) and from aiding and abetting violations of Section 13(a). In addition, she agreed to disgorge $379,808 plus prejudgment interest and to pay a civil penalty of $100,000. She also agreed to the entry of a five year officer-director bar.

Mr. Kenneally settled with the Commission by consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 10(b), 13(b)(5) and from aiding and abetting violations of Section 13(a). He also agreed to disgorge $126,676 along with prejudgment interest and to the entry of a five year officer-director bar. With these settlements the Commission concluded this action. See also Litig. Rel. 21609 (July 30, 2010).

Program: The Vanishing Line Between Civil And Criminal Securities Fraud: Sunday August 8, 2010, 10:30 a.m. at the ABA Annual Convention, San Francisco, CA. Co-chairs: Thomas O. Gorman and Frank C. Razzano. Panelists include: Hon. Cormac Carney, U.S. Dist. Court (C.D. CA), Greg Anders, Deputy Asst. AG, Criminal Division, DOJ; Michael Dicke, Associate Director – Enforcement, SEC, San Francisco; Ellen Podgor, Professor of Law, Stetson Univ. and Cheryl Evans, Special Counsel, National Chamber Law Reform Project.