While the comment period on the Securities and Exchange Commission’s proposed rules on executive compensation and related party disclosure came to a close this week, it appears the battle over what Corporate America will eventually have to tell the public about what they pay their executives and directors is just ramping up.
The SEC’s 370-page proposing release laid out detailed and extensive changes to existing disclosure rules that included the addition of new disclosure tables, changes to existing ones and the creation of a new reporting section modeled after the required Management’s Discussion and Analysis section. Not surprisingly, it evoked equally lengthy commentary from more than 100 respondents, representing all three main factions—companies, regulators and shareholders—jockeying for a voice in the discussion.
The SEC has not outlined any timetable for further action yet, but commissioners have indicated they want their new rules in place by the 2007 proxy season. While general agreement exists that current rules about what companies must disclose for executive and director pay sorely needs an update (they date back to 1992), several main ideas drew mixed reaction. Among them: a new Compensation Discussion and Analysis, a lower threshold for perquisites, elimination of the stock performance graph, the summary compensation table, and a requirement to disclose total compensation for some non-executives.
CD&A
As proposed, the new Compensation Discussion and Analysis section would provide narrative disclosure to explain material elements of the company’s compensation for named executive officers. Unlike the currently required compensation committee report and performance graph, which the CD&A would replace, the report would be “filed” rather than “furnished”—meaning liability for securities law attaches.
Some commenters, such as Richard Alpern of Frederick W. Cook & Co. and Jim Markey, vice president at Kellogg Company, called for the CD&A to remain “furnished.” Instead they recommended placing it over the names of the compensation committee members, since the CEO and CFO, who’s names would attach to the report if it’s filed, generally aren’t involved in the committee’s deliberations. Others, such as Institutional Shareholder Services, said the CD&A should be filed and placed over the signatures of the compensation committee members. ISS also called for all companies, including small issuers, to be required to file CD&A disclosures.
Jesse Brill, chairman of the National Association of Stock Plan Professionals, said the CD&A should be signed by the compensation committee, and doesn’t necessarily have to be filed. However, Brill argued that the CD&A needs more “specificity.” Brill said the CD&A is missing a “second prong of disclosure”—telling the shareholders what was the compensation committee’s assessment of and reaction to the numbers—and what actions the committee actually took when it considered the numbers. He suggested that the CD&A include a number of “mandated, fundamental headings,” such as Tally Sheet Review and Action, and Internal Pay Equity Review and Action.
Perks
Commenters’ views on the SEC’s proposed new $10,000 threshold for reporting the aggregate value of perks were mixed. Currently, companies must report a lump sum if an executive's perks exceed $50,000 or 10 percent of salary and bonus. Individual perks have to be reported only if they represent more than 25 percent of all the perks an executive receives.
SAMPLE COMMENTS
Below are excerpts of comments submitted to the Advisory Committee on Smaller Public Companies:
Richard Alpern
Frederick W. Cook & Co.
...We support the items to be discussed in the proposed Compensation Discussion and Analysis (“CD&A”) because they will be of significant value to investors. However, the CD&A should be over the names of the members of the compensation committee and the CD&A should be “furnished” and not “filed”. It is the compensation committee that is responsible for most of the elements of compensation of NEOs that are to be discussed in the CD&A. In our experience, actions by members of the compensation committee often take into account the disclosure that will appear in the Compensation Committee Report because the report is over their names. Requiring the PEO and PFO to certify the CD&A, which would be required if it is “filed,” would be very difficult since governance best practices and the rules of the New York Stock Exchange and the NASDAQ do not permit them to be present when their own compensation is discussed. In addition, the PFO is typically not present at compensation committee meetings...
Paul HodgsonSenior Research Assoc., The Corporate Library
...There are a multitude of problems associated with the proposed disclosure of perks; and it is easy to see, immediately, how companies can and will circumvent the law to avoid proper disclosure. The proposals say: “We also propose that each item of compensation included in the All Other Compensation column that exceeds $10,000 be separately identified and quantified in a footnote.”...
There is no real justification for any threshold, companies already track this expense, and there is very little likelihood that the information is not readily available. Therefore there should be no additional burden. Furthermore, the $10,000 threshold for separate identification is clearly open to abuse. Given that the threshold is being reduced because investors are interested in the “what”, not necessarily the “how much”, this lack of a requirement to identify separate perks is not even logical. Furthermore, it takes less than a nanosecond to figure out how to get around the rule. The only thing companies would need to is break perks down into tiny, less than $10,000 increments in order to evade disclosure. In this way, an executive could receive 10 separate, equally valued perks worth a total of $90,000 and not have to disclose any of them. Or, instead of disclosing a car allowance, the company breaks this down into a car leasing allowance, and a petrol allowance, and a car insurance allowance, and a chauffeur’s uniform allowance, and a chauffeur’s uniform cleaning allowance, and a car valet allowance, and a travel allowance per trip…. Pretty soon, you have all other compensation of $800,000, comprised of 800 separate items, none of which needs to be disclosed individually. Furthermore, with the proposed threshold, the absurd situation is still in place where a tax reimbursement on a perk has to be disclosed, but not the perk on which the tax is reimbursed. This clearly does not make sense.
Martha CarterSVP, Institutional Shareholder Services
The disclosure of up to three employees who are not executive officers but earn more in total compensation than any of the named executive officers will provide little value to shareholders without the appropriate narrative disclosure and the supplemental figures to support the total compensation figure. Unlike the named executive officers, the three non-officer employees are generally not individuals who have the ultimate authority over the company's strategic imperatives or broad business activities. Furthermore, these three individuals may change each year depending on their total compensation figures. The lack of continuous and consistent disclosure further dilutes the need for such information.
Source
Comments Submitted To The SEC On Executive Compensation And Related Party Disclosure
Paul Hodgson, senior research associate for The Corporate Library, called for the SEC to remove the $10,000 threshold for separate identification, which he said “is clearly open to abuse.”
“Given that the threshold is being reduced because investors are interested in the ‘what’, not necessarily the ‘how much,’ this lack of a requirement to identify separate perks is not even logical,” he said.
Hodgson, who said it takes “less than a nanosecond” to figure out how to get around the rule, then continued: “An executive could receive 10 separate, equally valued perks worth a total of $90,000 and not have to disclose any of them. Pretty soon you have all other compensation of $800,000, comprised of 800 separate items, none of which needs to be disclosed individually.” He added that under the proposed threshold, an “absurd situation” could result, where a tax reimbursement on a perk has to be disclosed, but not the perk on which the tax is reimbursed.
ISS also called on the SEC to remove the $10,000 threshold. “Inappropriate perquisites, even in small dollar amounts, may portend larger compensation problems,” said Martha Carter, ISS senior vice president and managing director of corporate governance. “We believe that having no minimum threshold would shed light on all types of perquisites provided to executives and would minimize any abuse in this area.”
Tables And Graphs
Citing concerns that the proposed disclosures in the Summary Compensation Table would be confusing, several commenters offered their own tweaks to the proposed new Summary Compensation Table. A number, including Watson Wyatt, Brill and Hodgson, said they preferred a two-table approach, which was mentioned in the SEC’s request for comments on page 59 of the proposing release, with one table showing all awards made during the year and another that would show all the amounts earned during the year.
Watson Wyatt said such a two-table approach could avoid the problems of mixing realized amounts of compensation and “opportunities” for compensation in the same table, and “mixing time frames associated with long-term incentive compensation in the same table.”
Commenters also split on the SEC’s plan to jettison the stock performance graph. While Hodgson agreed that the SEC should get rid of the graph, which would be replaced by the CD&A, several others, such as ISS, Watson Wyatt and Frederick W. Cook & Co. urged the SEC to keep the graph.
Retaining the performance graph to supplement the CD&A “provides investors with pay-for-performance context to compensation disclosure from the same disclosure source,” according to executives at Watson Wyatt. They said the graph may help ensure that the CD&A “addresses the degree to which the company aligns pay with performance, with regards to both total shareholder return performance and other measures of performance that affect the company’s compensation decisions.” Jana Reidy, a product manager at Standard and Poor's, agreed. “To eliminate the proxy performance graph would be a great disservice to all shareholders and potential investors,” said Reidy.
Disclosing Highest-Paid Employees
Several commenters opposed a requirement that would require the disclosure of up to three employees who aren’t executive officers if they earn more in total compensation than any of the named executive officers based on total compensation, not just salary and bonus.
ISS urged the SEC to remove the disclosure of non-officer employees. Carter said the information “will provide little value to shareholders without the appropriate narrative disclosure and the supplemental figures to support the total compensation figure.”
Unlike named executive officers, Carter said the three non-officer employees “are generally not individuals who have the ultimate authority over the company's strategic imperatives or broad business activities.” Noting that the three individuals may change each year depending on their total compensation figures, Carter added, “The lack of continuous and consistent disclosure further dilutes the need for such information.”
Alpern at Frederick Cook also opposed determining the other named executive officers based on the total column in the summary compensation table. “Many of the elements of compensation that are to be reported in that column are affected by individual circumstances and decisions that are unrelated to whether an executive officer is truly among the three most highly compensated officers other than [the CEO and CFO] for the most recent fiscal year,” Alpern said. To provide for “greater consistency” in the determination of the other named executive officers, Alpern said the determination “should continue to be based on salary and bonus only as currently provided under Item 402(a).”
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