The sweeping changes to the rules on executive compensation disclosure adopted by the SEC on July 26 have stirred up a spirited response – so much so that the consultation period generated more response letters than any other proposal in the commission’s history.
In addition to providing greater detail on executives’ pay and perks, companies also face new rules on the disclosure of stock option grants – no surprise considering the ongoing backdating scandal. Other aspects of the new rules hew closely to the original ones proposed back in January.
At the heart of the new rules, according to SEC chairman Christopher Cox, is the new compensation discussion and analysis (CD&A), which must be filed in the proxy statement, and a new compensation committee report, which only has to be ‘furnished’. Companies must also provide a summary compensation table showing the total yearly compensation for the CEO, CFO and next three highest-paid executives.
Two topics that drew criticism in the original proposal were deferred compensation and the so-called Katie Couric clause, a requirement to disclose the pay details of as many as three non-executive employees whose individual compensation exceeds that of any of the company’s top five execs.
‘I was surprised the SEC didn’t kill the Katie Couric proposal but instead reproposed it,’ explains Broc Romanek, editor for TheCorporateCounsel.net and a former member of the office of chief counsel of the SEC’s division of corporation finance. ‘As reproposed, this rule would carve out non-executive officers with no responsibility for significant policy decisions and would only apply to large accelerated filers,’ he adds.
Another contentious issue is that of earnings on deferred compensation. Under the original proposal, these payments were to be included in the summary compensation totals. Even early adopters of the proposed guidelines balked at this, however. Pfizer released a 29-page compensation committee report in its 2006 proxy but didn’t include earnings on deferred compensation in its summary compensation tally.
Double trouble
Like many critics, Pfizer’s corporate secretary and VP for corporate governance, Peggy Foran, points out that the SEC was in effect suggesting companies should double-count compensation: ‘We left it out of the tally sheet because the earnings are at or below the market. I can see the SEC’s point of view; some companies may have given sweeteners or alternative investments to executives with regard to the deferred compensation, so the SEC wants to see that.’
In fact, the SEC did what many critics had hoped. In the summary compensation table, companies are required to include only above-market or preferential earnings on deferred compensation, as opposed to all earnings.
The new rules also clarify whether the new CD&A will fall under CEO and CFO certifications. Professor Allison Garrett of Faulkner University’s Thomas Goode Jones School of Law had hoped the SEC would address the problem, but in fact, the CD&A must be ‘filed’ as opposed to ‘furnished’, putting it under the certifications.
‘Everyone agrees that the compensation rules needed attention, and most of the changes that have been made should help lay readers comprehend that section of the proxy statement,’ says Garrett, a former VP and general counsel of the corporate division and vice president of benefits at Wal-Mart. ‘However, after spending the past decade teasing apart the roles of the chairman and the CEO, the SEC has now inserted the CEO and CFO into compensation committee practices.’
The new rules and IROs
Just how much attention IROs are paying to the new rules depends on the company they work for. Those whose companies have relied more heavily on options or that have drawn investor scrutiny are more susceptible. For many, however, it’s business as usual, with at least three IROs contacted by IR magazine saying they haven’t paid much attention to either the proposal or the final rules.
IROs who are familiar with the new rules say Wall Street isn’t interested. ‘Our corporate secretary’s office is handling this, but the fact is, our transparency has been quite good in terms of disclosure for our top five executives,’ says Jerry Kircher, VP of IR at Lockheed Martin. ‘The issue doesn’t come up with analysts. To date, I haven’t had one call on the topic. So I think it’s going to be pretty simple in terms of adoption.’
‘We haven’t gotten questions at this point from investors,’ agrees Katie Sullivan, manager of IR at Staples. ‘I don’t see much of an impact for us. Last year we got a head start and made a lot of changes to our disclosure. We’ll have to change the packaging, but the information is there as of last year. For investors, the new rules make it easier to digest the information. More importantly, they make it easier to compare compensation from one company to the next.’
Richard Sinise, executive VP and portfolio manager at Kennedy Capital, says the new rules aren’t on his radar. He is interested in the new disclosure for stock options, but he notes that most of the information was already there, although perhaps less readily accessible. ‘We’re mostly interested in the total figure for options, as option-heavy companies are problematic for us,’ he says. ‘For us it isn’t necessarily an option timing issue, though of course it’s nice information to know.’
Early adopters
Companies that did not see the writing on the wall and proactively move to improve their disclosure in anticipation of the rules may face problems adapting. ‘I think there will be a lot of companies that will be sorry they didn’t pay attention to some of the inevitable changes that were set forth in the proposing release,’ says Anne Plimpton, counsel in the Boston office of law firm McDermott Will & Emery.
‘We told our clients not to wait to put in place the kinds of processes they’ll be required to disclose in next year’s proxy statement, since they would be more than halfway through the year that they will be required to describe by the time the final rules are published,’ she continues. ‘Some companies made changes in their 2006 proxies in anticipation of the new rules. Many started by trying to take the boilerplate disclosure out of the compensation committee report.’
Plimpton believes that compensation committees will struggle when it comes to preparing the new CD&A: ‘It’s a report of the company, but it’s based on what happened at the committee meetings. We’re telling committees that they need to make sure their minutes are comprehensive enough to provide a roadmap for what they actually did. Otherwise it will be very hard to write the CD&A.’
As Romanek points out, it will take time for the dust to settle on the rule changes. ‘Until we see the adopting release, we don’t know the full extent of the changes. Consider Sox – people didn’t complain about 404 for almost a year because they were focusing on the current rule-making at the time.’
