Less than one month into his tenure at the Securities and Exchange Commission, Chairman Chris Cox has put corporate America on notice that the issue of executive pay is high on his list of priorities. In recent public remarks, Cox suggested that the SEC will soon either revise existing rules or issue new rules related to executive compensation disclosure.
Cox
“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 in an interview this month with Nightly Business Report. He added, “The SEC is going to look at every possible way of making sure that our disclosure requirements are up to date and providing investors what they truly need” (see box at right).
The SEC through a spokesman declined to comment on Cox’s remarks or its current activities related to executive compensation. However, Cox’s statements are in line with previous comments by other SEC officials, including Alan Beller, director of the SEC’s Division of Corporation Finance.
Last October, in a speech to the National Association of Stock Plan Professionals, Beller made clear his view on the topic of disclosure. “Unless a company has disclosed all plan and non-plan compensation for all services rendered that is awarded to, earned by or paid to the executive officers and directors covered in the proxy statement, whether it is paid currently or deferred, it is not in compliance, literal or otherwise, with our rules,” Beller told NASPP members last fall. “And in my view that basic requirement to disclose all compensation takes precedence over the detailed requirements of the various tables in which disclosure is to be presented under our rules. All compensation must be disclosed” (see box at right).
Revisions In Next Six Months?
Beller indicated last Fall that the Commission was revisiting some areas of the disclosure rules, which date back to 1992. He said at the time that a group within the Division of Corporation Finance was in the early stage of considering what, if any, action it might recommend to the Commission regarding compensation disclosure.
Among the issues the group was looking at were the ways companies value perks and how they might be avoiding categorizing some items as perks; disclosure requirements related to supplemental executive retirement plans and non-qualified deferred compensation plans; whether enhanced disclosure of total compensation is needed and how it might be achieved; whether the current criteria for determining the named executive officers is still appropriate; and disclosure of overall director compensation. Other areas on the SEC’s radar screen include compensation committee report disclosure requirements and related-party disclosures.
While it’s unclear at this point when the SEC may take action, observers say companies should expect to see changes to the compensation rules sooner, rather than later. In addition, some experts said many companies are already increasing their disclosures.
McCoy
“We’ll probably see revised disclosure in this area in the near future,” said former Division of Corporation Finance attorney Michael McCoy, now an attorney at Bryan Cave. “I think this is one area where Chairman Cox will be examining new regulation.”
“I’d expect to see some proposals in the next six months,” agreed Ronald Mueller, a partner at Gibson Dunn & Crutcher, and a member of an American Bar Association joint committee on employee benefits that met with staff members from the Division of Corporation Finance earlier this summer. “It’s clear they [the Division of Corporation Finance] were working on putting together some proposals and trying to understand where the rules could be improved,” said Mueller, who noted that he expects clarification of the existing rules, as opposed to new rules.
“I think we can expect to see more specific rules saying, ‘This should be reported this way,’” said Mueller. However, he noted that, “It would be difficult to do something in time for this coming proxy season.”
Bryan Cave’s McCoy said the SEC could simplify the disclosure requirements by putting everything under one table, “so investors can look at one area rather than looking at three four or five tables to see what execs are receiving.” Or, McCoy said, the SEC might provide an interpretive release providing more clarity on what companies need to disclose without revising the rules.
The “Holy Cow” Moment
As indicated by Chairman Cox’s remarks, observers expect changes related to the timeliness of disclosure.
Mueller
“Right now, compensation is discussed only in retrospect,” said Mueller. “The proxy rules only require companies to disclose what was done for the last fiscal year, and the 8-K requirements are haphazard—they only require disclosure of certain elements of compensation,” said Mueller. “By the time the proxy is issued, some decisions on compensation for the coming year have already been put in place.”
Mueller said he expects some sort of requirement that compensation committees add to their reports information on their discussions of current year compensation, which he says some companies are already doing voluntarily.
COMPENSATION DISCLOSURE
The following excerpt is from a speech by Alan Beller, Director of the SEC's Division of Corporation Finance, at a compensation industry conference in San Francisco, Calif., in October 2004:
I want to close with a few thoughts about what we are considering regarding possible future developments for our executive compensation rules. I recognize that our rules in this area, which generally date from 1992, are very detailed and specific. So far as I can tell, the Commission went in that direction at that time because it was concerned that another approach would not capture all compensation and because the detailed tables fostered comparability over time periods and between companies. As I've already discussed, our rules currently require disclosure of all items of compensation. However, it may be time to revisit some areas of our executive compensation disclosure rules.
For example, the 1992 rules are not only detailed but also static. They may need updating to address more effectively new methods and approaches for executive compensation.
Therefore, a group within the Division of Corporation Finance is in the early stage of considering what, if any, action we might recommend to the Commission regarding compensation disclosure. While these thoughts are in a very preliminary stage, among the issues we are looking at are:
Perks. We are examining how companies might be inappropriately avoiding categorizing items as perks. We also are considering how companies value perks, and whether there are better approaches to valuation. In particular, is incremental cost to the company the best approach where the object of our requirements is to disclose compensation?
Retirement Benefits and Deferred Compensation. We have been reviewing our disclosure requirements, as well as companies' disclosure, related to SERPs and non-qualified deferred compensation plans, including our position regarding disclosure of above-market elements. We are also looking at other retirement, severance and change-in-control elements. We will also be considering the impact on those disclosures, if any, of the American Jobs Creation Act recently passed by Congress, which includes provisions related to the taxation of non-qualified deferred compensation.
Total Compensation. We are considering whether we should seek to provide enhanced disclosure of total compensation and how that might be achieved.
Named Executive Officers. We are also examining whether the current criteria for determining the named executive officers is still appropriate. For example, we are considering whether companies should be required disclose the compensation of other specific officers, such as the CFO and/or general counsel.
Director Compensation. We will also be looking at disclosure of overall director compensation, both to see if companies are following the current requirements, as well as whether our rules in this area should be expanded. We proposed rules in 1995 to expand the disclosure of director compensation. Those rules were not adopted.
Compensation Committee Reports. We are considering the current compensation committee report disclosure requirements and whether they adequately address disclosure of the policies, operation and determinations of the compensation committee. I should note in this area that, at the request of companies and their advisers and in an extra step to encourage transparency in these reports, the Commission provided that compensation committee reports are not "filed" under the Securities Exchange Act of 1934 and are not incorporated by reference in registration statements. I would submit that companies and their advisers have not reciprocated with more transparent disclosure. We may consider whether this special treatment should continue or how we can achieve disclosure that merits the treatment.
Related-Party Disclosure. Finally, it has been even longer since the Commission has addressed the relationship between Item 402 and the related-party disclosure under Item 404 of Regulation S-K. Several rules petitions have also been received in this area. We are therefore reviewing this area as it relates to executive compensation.
As I noted, all of this is in the preliminary stages of consideration by the staff. It is too early to tell what if anything we would recommend by way of rule-making or Commission interpretation. And of course anything that we might suggest would be subject to the Commission's decision.
Click Here To Read The Complete Speech Delivered By Alan Beller On Compensation Disclosure (Oct. 2004)
In addition, Mueller acknowledges a movement aimed at ensuring that compensation committees have a view of the total compensation package, including termination pay and change of control payments. “I call it avoiding the ‘holy cow’ moment,” says Mueller, “as in ‘holy cow, they’re entitled to how much?’”
However, Mueller noted that providing one number for total compensation may be problematic “because so much of pay is often in multi-year packages.” For example, asks Mueller, if a company grants an executive stock options that vest over four years, should the company tabulate what was granted in that total compensation number, or should the company count what vested or was exercised this year? “It’s hard to get good picture,” says Mueller.
Mueller expects to see more disclosure requirements related to restricted stock or performance-based stock, which he said are becoming more popular as some companies move away from granting stock options. “Currently, the disclosure on those two types of compensation is not as extensive as it is for stock options, probably because they were not as popular when the rules were written,” said Mueller.
The same goes for deferred compensation, such as supplemental executive retirement plans, an area in which Mueller said common practices and the types of arrangements have changed since the original disclosure rules were adopted. “There’s some uncertainty or variability in what people report,” he said. “I think there will be a move toward greater disclosure of the benefits accrued during a year, and information on how much a company would owe upon payout.”
“More Vibrant” Disclosure
Even without changes to the rules, experts say companies are taking the SEC’s stance on disclosure to heart.
“Disclosure has been far more vibrant than have in the past in reaction to what Beller said,” noted Steve Seelig, executive compensation counsel in Watson Wyatt’s Research Information Center. “We’ve been seeing much more robust disclosure in compensation committee reports.”
“The information is out there unlike ever before; disclosure is as robust as it’s ever been,” agreed Ian Singer, vice president at Aon’s eComp Data Services.
Seelig said more committees are including information in their reports to better reflect what they considered and adopted in an effort to protect themselves against questions about of business judgment. The issue of business judgment was highlighted in the recent decision in the Disney case, in which the board and officers were roundly criticized by a Delaware judge for allowing Michael Ovitz to walk away with a $140 million pay package, even though the court ultimately ruled that they properly exercised their fiduciary duty and did not commit waste when the company hired and then fired Ovitz.
“We do think and we have been recommending to clients that they spend a good deal of time trying to understand the different types of payments that could take place, including understanding the magnitude of payments that could take place in for cause terminations, change in control terminations, and retirement,” said Seelig.
Another area where companies are paying greater attention—and one that has been a hot button with the SEC—is executive perks. “During this past proxy season we’ve seen more companies disclosing virtually anything under the sun that execs could be receiving as perks,” said Seelig. He added, “We’ve seen more robust disclosures of difference between what executives might receive under a pension plan versus a non-qualified SERP. Although companies are not required to break those out separately, some companies have begun to move in that direction.
McCoy noted that companies are increasingly making negative disclosures about executive airplane use, a controversial perk that has come under fire by the SEC. “We’re seeing a lot of negative disclosures saying ‘we don’t allow it,’ which is unusual,” said McCoy.
Singer said that Aon’s eComp Data Services is also seeing increased disclosure of executive benefits. “We’re seeing benefit tables within some summary compensation tables in the footnotes,” he said. “Companies are more fully and adequately disclosing executive benefit details, and we’re seeing better disclosure of executive bonuses.”
Singer expects the SEC to require greater disclosure of director compensation, which he said has traditionally been explained in one paragraph. “As directors are being asked to do more, they’re being compensated more; that higher compensation needs to be more readily accessible,” he said.
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