Corporate governance is the use of policies, institutions, laws, and customs to mediate or prevent any conflicts of interest between shareholders and managers. Typically this structure is decided and enforced by a board of directors. There is a vast array of laws and policies which regulate corporate governance for public companies. If you run a public company or if your vision is to take your company public, it is vital to understand and follow the many corporate governance policies and to maintain the advice of counsel as these policies continue to be shaped.
Corporate Governance Laws
The two main pieces of law shaping corporate governance of public companies are the Sarbanes-Oxley Act (“Sarbanes-Oxley”) and the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). In 2002, Sarbanes-Oxley set new standards for all U.S. public company boards and accounting firms in response to a series of corporate scandals, including those involving large companies such as Enron and WorldCom. It is used as the basis for corporate governance of public companies. The Dodd-Frank Act, signed into law in July 2010, implements policies that affect financial aspects of corporate governance.
Sarbanes-Oxley requires every public company to have an audit committee composed of independent directors. It is responsible for hiring the company’s auditor and for receiving the reports directly from the auditor. Each company is highly encouraged to have at least one financial expert on its audit committee or disclose a reason for not having such an expert. The expert should have an understanding of general accounting principles, internal control, and the role of an audit committee. Whistleblower rules were also introduced to protect employees who report financial inconsistencies from retaliation.
Executive Compensation Committee
Under Section 952 of the Dodd-Frank Act, a compensation committee must be established, and its members must be independent, which means they cannot be affiliated with the company or any of its subsidiaries.
The Dodd-Frank Act also requires public companies to disclose executive compensation in a Compensation Disclosure and Analysis, to be filed with the Securities and Exchange Commission (“SEC”).
The Dodd-Frank Act also implements a new “say on pay” policy requiring public companies to include a separate non-binding resolution in their proxy materials where shareholders must vote to approve executive compensation. The frequency of this vote can be taken annually or every two or three years. A separate shareholder resolution must be voted on to determine the frequency no less than every six years.
To date, the SEC has postponed the issuance of the rules on executive compensation, with an estimated implementation of these rules to occur in the second half of 2012. Visit the SEC’s rulemaking implementation website at http://www.sec.gov/spotlight/dodd-frank/dfactivity-upcoming.shtml#tobedetermined for updated information about these policies.
Sarbanes-Oxley requires an extensive amount of reporting in order to curb accounting or managerial errors. Under Section 302 of Sarbanes-Oxley, public companies must submit a quarterly report to the SEC disclosing any errors that have been found and corrected in accounting policies. Section 404 requires public companies to disclose any significant weaknesses in internal control in an annual report. The Dodd-Frank Act requires additional disclosures from the board of directors. These reporting policies are intended to help companies curb fraud and misstatements by recognizing and correcting problematic policies.
Complying with Corporate Governance Policies
Corporate governance is complex and requires close attention to regulatory details. The attorneys at Horwitz + Armstrong, LLP have provided comprehensive counsel to public companies concerning corporate governance issues for more than 20 years. For more information, please contact Larry Horwitz at firstname.lastname@example.org. Think your private company isn’t bound by these rules? Our next post will discuss corporate governance for private companies.