Backdating Lawsuit Puts Boards, Comp Consultants on Edge
An option backdating lawsuit that names the board of Cablevision Systems and the compensation consultant it hired as defendants is altering the way boards and consultants interact.
New York-based Lyons, Benenson & Co. has the undesirable distinction of being the first known comp consultant to be named in a lawsuit along with management and directors for option backdating at the $5.2 billion cable television provider. The trial is scheduled for late March.
Claudia Allen, a partner at the law firm Neal, Gerber & Eisenberg, says the attempt to name consultants in the backdating case probably does not recuse directors of their own liability, but does change the relationship between comp committee members and the experts they hire.
Consultants have gotten much more circumspect in dealing with boards. Some consultants are starting to require boards to sign waivers, indemnifying them against taking blame for shareholder lawsuits against pay practices. Allen says directors should “think long and hard” before signing a waiver and be sure to read the fine print.
The SEC’s new compensation disclosure rules will, among other things, shine a bright light on comp consultants. The new rules, which take effect next month, require companies to disclose the names of and methods used by the compensation committee’s consultants. This will raise the profile of comp consultants, says Paul Dorf, managing director at Compensation Resources.
It will also require comp directors to be more diligent in making sure the consultants they use are independent from management, Allen says.
Dorf says if so-called experts hired by the board encourage or participate in illegal pay practices, they absolutely should share in the blame with directors. He says prosecutors are beginning to place as much of a burden of responsibility on comp consultants as they do auditors when it comes to due diligence, though they have different roles in advising boards.
Cablevision announced in August, when the backdating scandal was exploding, that it had backdated its own options from 1997 to 2002. But the company stands apart from other companies for the deceptive methods it used, including granting options to a dead executive and a compensation consultant.
Dorf says boards and compensation consultants should expect similar suits in the future. “I think this is not an isolated case, and I think clearly this is what we’re going to see more of,” Dorf says of consultants being sued for recommending or participating in illegal compensation practices.
Bill White, a director at Reader’s Digest Association and Packaging Dynamics and a professor at Northwestern University, has a different viewpoint as to where the bulk of liability around executive pay packages lies. He says the board alone should be responsible for the pay practices it approves. And greater transparency mandated by the SEC should focus on the methods and rationale used for executive pay packages — not whom the committee used as a consultant, he adds.
Consultants used to recommend executive pay packages that would get approved in their entirety by directors. Now directors are educating themselves to understand the metrics behind compensation packages, according to White.
Board search firms predict that executive pay experts will be in high demand on the comp committee as the new compensation disclosure rules take effect. White says that boards should long ago have been thinking about having a compensation expert sit on the comp committee — just as they should have anticipated the need for a financial expert. This might have prevented some egregious pay practices, like option backdating, from becoming so widespread.
Joseph Bower, a member of the comp committee at Brown Shoe and a chair of the comp committee at Loews Corporation, agrees with White’s argument that it is the board’s responsibility to instruct consultants and use their recommendations as the committee sees fit. “Otherwise, the consultants belong in the proxy,” Bower writes in an e-mail to Agenda. In fact, that will soon be the case with the new disclosure rules.
“I think comp is a big issue — but it is a fundamental one that should be well understood by the board. If they don’t [understand it], they have a problem,” Bower writes.
Increasingly, consultants are listening more to the comp committee members instead of telling them what type of pay package they should award, White says. This puts the onus more on directors than consultants to grant pay packages that are ethical and geared more toward long-term performance of the company. With shareholders raising the profile over egregious pay packages, a brighter spotlight will be cast on directors over whom they are hiring to give them advice — regardless of whether or not the consultants are liable to be named alongside directors in a lawsuit.
