I hate to say “I told you so”—but I did. About a year ago, I went through the ridiculous task of searching through nearly 6,000 “material definitive agreements” that had been filed by public companies since the Securities and Exchange Commission’s revised Form 8-K rule became effective.
As I wrote in this column back in February 2005, the rule—which requires companies to disclose an expanded number of items—had caused companies to over-disclose agreements that were hardly material. The reason, of course, had little to do with informing the investing public; rather, the disclosures were driven by a fear of litigation and enforcement. After all, General Electric had just been excoriated for failing to describe plush retirement benefits it had agreed to provide former CEO Jack Welch, and many companies were being warned by counsel that even the most minute contracts were “material” and should disclosed.
As a result, companies were literally vomiting up contracts, many of them compensation related: stock awards, trading plans, retention plans, savings plans, pension plans, severance letters, bonus programs, non-competition agreements, and more.
My favorite at the time was the disclosure that Las Vegas developer Steve Wynn had leased a villa suite at his new resort with his wife. Bryan Cave partner Heather Badami agreed with me that the Wynn disclosure represented the type of over-sharing that was likely creating noise in the marketplace, distracting investors from more critical data. “That Mr. and Mrs. Wynn have a nice place to live on the same terms as the other tenants does not seem to require such an alert to the public,” Badami told me at the time.
Now, I’m not saying that some of these contracts weren’t material or required; the 8-K amendment included a cross-reference to Item 601(b)(10) of Regulation S-K, in which compensation agreements with named executive officers and directors are deemed material no matter how small the amount.
But many of the disclosures bordered on irrelevant.
And apparently the SEC agrees.
According to the Commission’s newly proposed executive compensation disclosure rules, the revised Form 8-K amendments have “triggered compensation disclosure of the types of matters that, in some cases, appear to fall short of the ‘unquestionably or presumptively material’ standard associated with the expanded Form 8-K disclosure items.”
Citing my column—yes, apparently someone other than my mother-in-law actually reads this drivel—the SEC stated that “we propose to amend Item 1.01 of Form 8-K to eliminate employment compensation arrangements and to cover such arrangements under a modified broader Item 5.02.”
That the SEC wants to pursue a “more balanced approach” to compensation disclosure matters is good news.
But here’s the reality check: Simply moving the 8-K disclosures from Item 1.01 to Item 5.02 doesn’t help companies or investors much, nor does it help when you’re actually expanding the information and items to be disclosed. Though grants and awards won’t have to be disclosed if they are consistent with other plans and are disclosed as per Item 402 of Regulation S-K, securities experts tell Compliance Week that the 8-K modifications likely won’t dramatically change public company practices.
So much for a more balanced approach.
Principles-Based What?
Unfortunately, the compensation disclosure proposal represents another missed opportunity for the SEC: living up to the principles and standards to which it expects its subjects to adhere.
Back in July 2004, I wrote in this column that if the SEC were graded on compliance with its own regulations, it would fail, miserably. In that column, I took on the Commission’s failure to meet the standards that it imposes upon the companies it oversees, including its failure to disclose information to public companies on a “rapid and current basis,” and its penchant for violating the tenets of Regulation Fair Disclosure by consistently making “selective disclosure” of important policies in letters, speeches and briefs that most public company executives never see.
The compensation disclosure proposal represents another such failure: the propagation of another rules-based standard, instead of principles-based standard.
As you likely know, the global accounting and securities communities are currently engaged in a debate on what should drive the standards for the 21st century and beyond: principles, or rules?
Besides pushing the exchanges and FASB to use principles-based standards, the Commission itself is supposedly committed to a principles-based approach. In July 2003, the SEC published a study on such an approach, as required by Sarbanes-Oxley, recommending that “those involved in the standard-setting process more consistently develop standards on a principles-based or objectives-oriented basis.”
That was two-and-a-half years ago. Since then, while the SEC has spoken out in support of such an approach, it has done little. In a videotaped address at a recent AICPA conference, SEC Chairman Christopher Cox acknowledged that convolution in U.S. accounting standards “is now reducing its usefulness,” but the Commission doesn’t appear interested in taking the lead on the issue.
The SEC’s proposed rule changes regarding executive compensation disclosure are a perfect example. The document, weighing in at 370 pages, is jam packed with the types of rules-based minutiae that the Commission supposedly wants to avoid. And while some of the provisions—including the proposed Compensation Discussion and Analysis section, and the SEC’s resistance to defining specific items like “perks”—are indeed principles-based, the bulk of the requirements continue to propagate a rules-heavy mentality that appears contrary to the Commission’s stated position.
Tim Ranzetta, the president of compensation research firm Equilar, agrees that “the enhanced disclosure of perquisites, severance/change in control arrangements, defined benefit and deferred compensation fit more into the ‘rules-based’ camp, as the SEC proposal provides detailed description on how information is to be disclosed in tabular format—excluding severance/change in control—as well as the narrative that accompanies these tables.” And, as expected, the rules-heavy requirements won’t be without their challenges. “These rules seem intended to achieve comparability, which may continue to be challenging given varied assumptions used to derive these figures,” Ranzetta adds.
In theory, the proposal could have been one sentence: “The proposals that we publish for comment today would require that all elements of compensation must be disclosed.” That sentence was actually part of the 370-page proposal (page 10, if you’re interested), and it represents the essence of what could have been the entire rule. The combination of a “disclose it all” philosophy and XBRL tagging could theoretically have provided the same level of transparency and comparability as the SEC’s rule proposal.
An absurdly simplistic and naïve proposition? Perhaps. But if the accounting and disclosure frameworks are going to migrate to principles-based standards, the Commission will need to impose on itself the same types of legal constraint it asks of others.
Public companies have been bemoaning complex rules, nit-picky accountants, and aggressive enforcement that threatens to penalize reasonable judgment. But the FASB can’t promulgate a less complex, principles-based system of financial reporting until the SEC itself demonstrates it is pursuing a principles-based framework in its rulemaking and enforcement initiatives. We’ve written about this circular argument in the past: Regulators say they’re committed to creating a less complex, more principles-based system of financial reporting, but they need more cooperation from accountants and preparers. Accountants, on the other hand, say they’re pleased with regulators’ interest in simplifying accounting rules, but need some cues from regulators that they’ll not be punished in the enforcement arena for exercising reasonable judgment.
If the Commission truly wants to migrate U.S. accounting standards to a more principles-based approach, it’s got to start practicing what it preaches.
Tone starts at the top, and in this case, “the top” is the SEC.
This column solely reflects the views of its author, and should not be regarded as legal advice. It is for general information and discussion only, and is not a full analysis of the matters presented.
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