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L&A Original Article: Compensation Risk Assessment- Supporting Your Claims & Avoiding Exposure

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In July 2010 Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act; primarily, as a response to the financial crisis of 2007-2009. A key provision under Dodd-Frank requires public company directors to determine if the company’s compensation and governance programs incentivize or exacerbate company risk. Additionally, this rule requires companies to provide commentary within their proxy statement or annual filing that disclose compensation practices that may present material risk to the company and/or incentivize excessive risk-taking measures.

Over the past 8 years, well over a majority of public companies have given little attention to this risk assessment required by Dodd-Frank. If a company does provide a statement in the proxy, it is generally a generic description, such as: “Our Independent Compensation Committee, with assistance from our Independent Compensation Consultant, has reviewed and opined on our compensation programs as they relate to risk. Based on our Consultants external third-party review, it was determined that our compensation policies and procedures do not carry excessive risk profiles that are reasonably likely to have a material adverse effect on the company”. This generic disclosure may be leaving valuable shareholder goodwill on the table. L&A understands there will be some risk profile associated with most compensation programs; however, providing a more robust description of the method, measurements, and specific findings of the risk assessment will allow existing and potential shareholders a more complete picture of the organization. In order to provide this complete picture, L&A has developed an 80-point assessment. A snapshot of the assessment is as follows:

  • Compensation Philosophy: The alignment of total compensation and/or individual areas of compensation relative to the external competitive market versus company desired placement.
  • Mix of Compensation: The makeup and relative relationship between each item of compensation; specifically, base salary, bonus/non-equity incentive, equity or equity equivalent awards, change-in-pension, and all other compensation arrangements.
  • Measurements to Determine Performance: The specific measures, relative weightings of each measure, and rationale behind why each measure was determined for inclusion.
  • Goal Setting & Probability of Achievement: Disclosure regarding how and why goals were set and utilized for inclusion within the compensation program and each measurements probability of achievement at threshold, target, and maximum levels.
  • Final Calculation & Independent Review: Similar to an audit of the company financials, an independent review of the calculations and input variables utilized in the determination of any formulaic incentive payout opportunity.

In addition to the above, each of these items should be included within the CD&A as a material discussion. Specifically, L&A recommends a summary of the overall conclusions and findings of the review and mitigation steps the company has taken to reduce the potential risk to the most minimally acceptable levels. L&A believes this is a growing concern within boards due to potential exposure risks that may occur by disclosing in an SEC filing that their respective companies’ compensation programs do not entice excessive risk but are unable to proactively support these disclosures. L&A’s holistic approach and multi-point risk assessment will identify potential red flags to be addressed while ensuring SEC compliance. Contact L&A’s assessment specialists to conduct a comprehensive independent risk assessment and sharpen your proxy statement disclosure.