House Bill Add Fuel To Comp. Disclosure Fire

Congress has thrown its weight behind the already strong regulatory push to improve the transparency of executive pay. But with the 2006 proxy season fast approaching, companies are still waiting to see what, if any, changes will take effect in the coming months.

As public companies await rulemaking from the Securities and Exchange Commission that is expected to expand the disclosure of executive compensation, Congress put its own pressure on companies to improve their disclosure of executive pay with the introduction this month of legislation seeking increased disclosure of executive compensation.

Frank

“The Protection Against Executive Compensation Abuse Act,” sponsored by Rep. Barney Frank (D-Mass.), would, among other things, require public companies to include in annual reports and proxies a comprehensive “executive compensation plan,” that would have to be approved by shareholders. That plan would also need to include full disclosure of top executives’ compensation; disclosure of compensation policies for top executives, including the short and long-term performance measures or targets used to determine compensation; and a so-called claw back provision enabling companies to recapture incentive compensation in cases where subsequent financial results show it was unjustified.

In addition, the bill would require separate shareholder approval of golden parachute packages that coincide with mergers or acquisitions, and would require companies to include on their Web sites what it describes as “clear and simple disclosures on the company’s compensation filings made to the SEC rather than forcing shareholders to regularly monitor and decipher the SEC’s arcane ‘EDGAR’ database.”

Russo

At least one expert says the bill’s requirement of a comprehensive executive compensation plan is “somewhat duplicative” of existing requirements. “It adds more complication without adding more clarity,” says Raphael Russo, a partner in the corporate department of Paul, Weiss, Rifkind, Wharton & Garrison, who says the annual proxy statement is becoming a “morass” for issuers.

With the SEC, the stock exchanges and governance rating services all weighing in with their own criteria for what companies should include in their proxies, some say the federal bill doesn’t exactly clarify the situation. “It’s already very difficult for issuers to get their proxy statement right with all of the competing bodies asking for different things,” says Russo. “This doesn’t strike me as so compellingly different.”

The House bill “hits a lot of hot buttons that institutional shareholders have been particularly concerned about,” says Edward Smith, a partner in the corporate practice at Chadbourne & Parke in New York.

For example, he says shareholders have been frustrated because they can't directly control executive compensation; under state corporation laws, directors and the compensation committee have authority to approve executive compensation. Currently, shareholders don’t vote on the executive compensation packages, but they have indirect ways of expressing their unhappiness with executive pay—by voting out board members or compensation committee members who approve executive compensation, notes Smith.

Smith

But a provision of the proposed bill would give stockholders the power to approve certain aspects of compensation, such as so-called golden parachutes in the case of a sale. According to Smith, this would be “an extreme departure from federal involvement in corporate matters.” Currently, while stockholders can vote on mergers and acquisitions, corporate boards can approve the executive payouts that are often tied to those transactions without submitting them to stockholders.

However, Russo points out that since such approval would only apply only in merger and acquisition transactions that require a shareholder vote, “That’s a specific situation that would only affect a small number of companies a year.”

Accelerating SEC Action

Dicker

Howard Dicker, a partner in the corporate department at Weil, Gotshal & Manges, says he would expect the shareholder approval requirement concerning compensation disclosure would draw considerable opposition. However, he notes that a shareholder vote on compensation disclosure is not unprecedented. “In the United Kingdom,” says Dicker, “there is an advisory vote by shareholders of the director’s remuneration report.”

Smith also notes that the way the legislation is written, since the executive compensation plan must be approved by shareholders, “if a company wants to add a new benefit or item of compensation, it would seem like the company would have to go to stockholders for approval.”

While the bill would require a company policy for recapturing incentive compensation, experts note that Section 304 of the Sarbanes-Oxley Act includes a claw back provision that requires the forfeiture of executive bonuses in the event of earnings restatements. “That provision is only about three years old,” says Russo. “We don’t have a lot of experience yet understanding how that would work, and we haven’t been a lot of cases testing how effective it is,” he adds. “I’m not sure that until we have more experience with the existing claw back under SOX that adopting another one is so helpful.”

Edwards says the House bill could serve to spur the SEC to act more quickly. SEC officials have repeatedly said the issue of compensation disclosure is a high priority for the Commission (see related coverage above, right). The existing SEC rules related to compensation disclosure have been around for about 10 years, and SEC staffers have stated publicly that the Commission believes it’s time for an update.

In public remarks made in August, SEC Chairman Chris Cox suggested that the SEC would soon either revise its existing rules or issue new. “I think you can look in the near future to the SEC for some improved rules on disclosure to make sure that, for example, shareholders can have one number, that the different kinds of executive compensation add up to a number that’s comparable executive to executive and company to company and at the same time that this information is provided in a timely way before rather than after the fact,” Cox said at the time.

And, in an often-referred to speech made last year, SEC Corporation Finance director Alan Beller said the SEC staff was looking at, among other issues, the ways companies value perks; disclosure requirements related to supplemental executive retirement plans and non-qualified deferred compensation plans; the need for enhanced disclosure of total compensation; the criteria for determining the named executive officers; and disclosure of overall director compensation.

But with the start of 2006 proxy season drawing near, the SEC has yet to issue any rulemaking. Nevertheless, most expect action on this issue to come from the Commission, and not Congress. “This bill will probably accelerate the SEC's promulgation of the new revised disclosure rules,” says Smith at Chadbourne & Parke.

“I suspect that SEC will move to take action faster than Congress will act,” agrees Russo at Paul, Weiss. However, if the SEC wants to put new rules in place or revise the existing rules before the next proxy season, Russo says, they would need to do it immediately. “Most companies begin publishing their proxy statements with their executive comp disclosures in March or April,” he says, “and they start compiling that data in late January or February.”

Smith at Chadbourne & Parke agrees. “It's so late in 2005, I think it will be difficult for [the SEC] to have effective new rules for the 2006 spring proxy season,” he says. “I suspect we'll have new SEC executive compensation disclosure rules in effect by 2007.”

Dicker at Weil, Gotshal & Manges says he doesn’t expect the legislation to impact the SEC’s actions. “I believe that the SEC is so close to proposing new rules that this very recent bill proposal is unlikely to make drastic changes,” Dicker tells Compliance Week. “I would expect the concept of greater transparency from the bill would be included in any SEC rule making,” he adds. “In any forthcoming SEC rulemaking, I’d expect there to be greater focus on supplemental executive retirement plans, pension plans, perquisites, as well as a renewed focus on better transparency concerning all types of compensation.”

In the meantime, Russo says companies would be well-advised to focus on making sure the compensation committee is evaluating executives’ overall packages, and that they understand how all of the pieces fit together. “All of these watchdogs want to see a degree of transparency and a comprehensiveness to disclosure that they think is lacking,” he says.