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SEC Calls For Better Executive Compensation Disclosure
11/09/04
By: Susan Schott Karr, Complianceweek.com
The Securities and Exchange Commission is considering steps that would require more meaningful and complete disclosure of executive compensation in public filings. That’s according to Division of Corporation Finance Director Alan Beller, who described the Commission’s new emphasis on compensation transparency at an industry conference in San Francisco.
The speech comes on the heels of recent inquiries into pay-related disclosure practices; in September, the Commission entered a cease-and-desist order against General Electric for inadequate compensation-related proxy disclosures. And though no big compensation-related rule changes appear on the Commission’s docket, Beller’s comments make clear that companies should treat with reverence the disclosure of executive compensation as well as the policies, procedures, and controls they employ to award such compensation.
Current Disclosure Requirement
The existing mandate is described in Item 402 of Regulation S-K, which sets forth required disclosures with respect to executive compensation. The purpose of the Item 402 disclosures is to improve shareholders' understanding of executive pay, calling for “clear, concise and understandable disclosure about the amount and type of compensation paid to chief executive officers and other highly compensated executives of public companies.”
But since Item 402 was codified in 1992, executive compensation has diversified into a complex matrix of offerings that includes cash, bonuses, stock options, perquisites, and—increasingly—variations of restricted stock, some of which might be performance based. And, of course, there are also retirement benefits, like the employment and post-retirement consulting arrangement granted to former GE CEO Jack Welch. The package, which was the subject of the SEC’s recent action, would have provided him with “lifetime access to the perquisites and benefits he had received as GE's chairman and CEO.”
According to Beller, what concerns the SEC is the obfuscation of information. “The keynote in the policy regarding disclosure is transparency,” said Beller of the Item 402 requirement. “Tell investors what is going on. Don’t hide the ball. The policy couldn’t be clearer in this regard.”
But according to Broc Romanek, editor of the Web site CompensationStandards.com that hosted the event with Beller, following the letter of the law may not be enough. "For those involved with drafting proxy compensation disclosures,” says Romanek, “Alan’s speech must be reviewed as he made clear that literal compliance with Item 402 is not compliance in the compensation disclosure area."
Intolerance For Ambiguity
According to Patrick McGurn, special counsel to Institutional Shareholder Services, Beller’s speech wasn’t just about what companies might be required to do in the future—it was about what they should be doing under existing rules. “[Beller] tends to think it’s an issue of under-disclosure or incorrect disclosure,” says McGurn. “Follow the existing rules and we won’t have any problem.”
According to Beller, “Too many issuers and their advisors have followed a pattern of opaque or unhelpful disclosure that confirms the worst suspicions of concerned investors.” That’s because investors automatically assume that a company’s failure to disclose information, or failure to communicate in plain English, implies that something is wrong. “Whether or not they are in fact true, there’s something to hide, and it’s being hidden.”
An example, says McGurn at ISS, is “stealth pay” like deferred compensation that is obscured through confusing disclosures. Another is board compensation practices that are vague or convoluted. “Director compensation is not clear today,” he says. “Companies don’t need to give itemization, [but] people want to read the facts and want a picture of the totality.”
Part of the problem, some say, is that the Item 402 disclosure requirement itself is vague. But Beller disagrees. “Let me help,” he told conference attendees. “Disclosure is required of all compensation earned or paid from all sources for all services.”
That being said, Beller acknowledged the possibility of changes. “The 1992 rules are not only detailed, but they’re also static,” he said. “They may need updating to address more effectively methods and approaches to compensating executives.
Among the issues the SEC staff is apparently reviewing are:
- Inappropriate categorization of items as perks;
- Valuation of perks and whether there are better methods, in particular, the incremental cost;
- Retirement benefits and deferred compensation, including disclosure of nonqualified deferred compensation plans, and supplemental executive retirement plans
- Severance-contingent control elements;
- Appropriateness of criteria for naming and selecting officers;
- Possible disclosure for more than the top five officers, to include the CFO or general counsel;
- Director compensation;
- Compensation Committee reports;
- Related-party disclosure.
“All of this is in the preliminary statement for consideration at the [SEC] staff level,” says Beller. “It is too early to tell, what if anything we would recommend, by way of rule-making or interpretation, and of course anything that we might suggest is subject to the Commission’s decision.”
Changes Needed?
Some experts argue that regulatory changes may not be needed.
“The rules are perfectly adequate as long as you don’t try to play it fast and loose,” says Michael Segal, a partner at Paul, Weiss, Rifkind, Wharton & Garrison. According to Segal, who co-chairs the firm’s Employee Benefits and Executive Compensation Group, the key issue is how clearly companies communicate the information. “The question isn’t whether the information is publicly available,” he says, but rather, “Where is it?”
To those ends, Segal recommends clear, simple disclosures. “Don’t be creative,” he says. “You’ll be punished for being creative.”
A key element of the 1992 SEC rule is the “Summary Compensation Table,” which outlines the compensation of executive officers; in August 2003, the Commission published a compensation guide for investors that described the compensation table as “the linchpin of the Commission's executive compensation disclosure.” The table includes information on the executives’ base salary, cash and non-cash bonuses, and other compensation like perks, stock grants, option awards, and other long-term incentive pay. In annual proxy statements, companies must also disclose the criteria used in reaching compensation decisions, as well as relationships between pay packages and corporate performance.
According to Segal, most companies accurately utilize the Summary Compensation Table, but questions often remain about how best to disclose information in narrative form. For example, Segal asks, how detailed does a company have to be regarding employment agreements? “If there are 20 pages in the agreement and you have to boil it down to two-thirds of a page, it’s not clear where to draw the line as to what to include.”
McGurn at ISS agrees that this is a problem. “Companies comply with the letter, but not the spirit; they fill in all of the boxes.”
That makes the fine print important to scrutinize, especially as companies seek to gain industry and peer-to-peer comparisons. “When you look at the proxy statements, you have to read the footnotes very carefully,” says Paul Dorf, managing director of Compensation Resources, Inc. “People hide the facts, so they don’t jump out at you.”
In addition, Dorf says companies can ostensibly circumvent disclosure requirements by setting vague performance criteria for executives, or by utilizing plans that avoid disclosure of proprietary criteria. “A lot of the laws currently on the books on disclosure have been abrogated: people have gotten around them.” In addition, companies often fail to disclose details of changes over time. “If you look at these documents very meticulously, you will see that the data reported changes over the years,” says Dorf, often without explanatory footnotes.
According to David Drake, managing director of Georgeson Shareholder, analysis of compensation requires a lot of effort, requiring investors to consider “What’s missing? What’s hidden? What isn’t there that should be there?”
The SEC staff apparently thinks it shouldn’t be that difficult. We’ll keep subscribers abreast of developments as they occur. Documents related to this article are available in the box above, right.
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