Non-Mandatory Provisions of Dodd-Frank Act as Guidance for Small Companies

December 2010

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (commonly referred to as the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act was enacted in response to the recent Wall Street crisis, in an effort to restructure the regulatory framework that governs the banking and financial system. In the words of SEC Chairman Mary L. Schapiro, “[t]his law creates a new, more effective regulatory structure, fills a host of regulatory gaps, brings greater public transparency and market accountability to the financial system and gives investors important protections and greater input into corporate governance.”

Most of the provisions of the Dodd-Frank Act are generally applicable to public companies, subject to exemptions that the securities exchanges may adopt (taking into account in particular the impact on smaller public companies). However, there are some provisions of the Dodd-Frank Act that are applicable only to larger “financial services” companies such as certain publicly traded nonbank financial companies that are supervised by the Board of Governors of the Federal Reserve System and publicly traded bank holding companies with consolidated assets of $10 billion or more. While these provisions are not binding on the majority of public companies, all public companies may want to consider adopting them as “best practices” ideals for corporate governance.

Section 165 of the Dodd-Frank Act requires that these larger financial services companies establish mandatory risk committees in order to promote sound risk management. These risk committees are responsible for the establishment of and monitoring compliance with enterprise-wide risk practices. The Federal Reserve Board of Governors
is responsible for promulgating regulations determining how many independent directors such risk committees must include, and the risk committee must also include at least one “risk management expert” who has experience in identifying, assessing and managing the potential risk exposure of large, complex financial service businesses. While not required, smaller firms that engage in businesses with potential risks such as leverage, currency fluctuations or interest rate variations should consider establishing a risk committee to fulfill the same functions. Establishing such a committee is an effective method of addressing concerns from shareholders, creditors and business partners that a company is taking all appropriate steps to manage such risks. The final rules relating to risk committees are to be issued by the Federal Reserve Board of Governors by July 2012.

Section 956 of the Dodd-Frank Act addresses the disclosure of incentive-based compensation structures. This section is mandatory for all “covered financial institutions,” which include banks, registered broker-dealers, investment advisors and similar entities with assets of more than $1 billion. Entities of these types with less than $1 billion in assets are, for now, exempt from this provision. This section requires that the “appropriate federal regulators” (which may be more than one agency) issue guidelines that require such covered financial institutions to disclose to the regulators the structures of all incentive-based compensation arrangements in order to allow the regulators to determine whether or not these structures provide executives, employees, directors or principal shareholders with excessive compensation, fees or benefits, or otherwise could lead to material financial losses. In addition, the regulations to be issued will provide that any plans of this type are prohibited. Disclosure of individual compensation is not required; rather, the compensation plans themselves are what must be disclosed, and it is expected that the plans will be kept confidential by the reviewing regulators. The Dodd-Frank Act requires that any of the regulations established are comparable to the standards for compensation set forth in Section 39 (c) of the Federal Deposit Insurance Act. The Federal Reserve Board of Governors has recently issued guidance on incentive compensation plans that states that such plans should provide employees with incentives that appropriately balance risks and rewards, be compatible with effective controls and risk management, and be backed up by strong corporate governance and oversight. These are guidelines that all companies, not just financial services companies, should strive to comply with.

While neither of these provisions of the Dodd-Frank Act are applicable to the vast majority of public companies, both of them provide sound guidance for any company to consider when analyzing how best to deal with corporate governance issues in what is sure to be an evolving marketplace. Even if these requirements are never made mandatory to a wider range of public companies, adopting a risk committee and engaging a third party to review incentive compensation plans would show that a company is committed to operating in accordance with the highest standards, even beyond those that are statutorily mandated. For additional information on this topic, please contact Mark Tarallo at mtarallo@mbbp.com.

For additional information on best practices for corporate governance, please do not hesitate to contact Mark J. Tarallo or any other member of the Public Company practice group.

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