Under the wire

Feb 01, 2007
<p>&bull; SEC makes last-minute changes to options disclosure rules<br />&bull; Revisions mean a lot of preparation work has been wasted<br />&bull; Governance activists not pleased, but investors seem unconcerned<br />&bull; Many corporate secretaries think changes will have little effect<br />&bull; Compensation disclosure rules may be a waste of time, money</p>

It was called a Christmas gift for corporate executives, but it certainly wasn’t a reward for corporate secretaries. On December 22, the SEC suddenly revised the reporting requirements for stock options, stating that the summary compensation table only must show options vesting in the current year.

Critics read the move as an about-face by the SEC following its overhaul of compensation disclosure this past July. House Financial Services chairman Barney Frank warned that Congress might need to act, and the Council of Institutional Investors (CII) called it a ‘holiday present for corporate America.’

‘We are disappointed because in some cases this will mean that the report of compensation will be lower than it should be, and we think investors should get the full picture of what the board gives,’ says Amy Borrus, deputy director of the CII.

Specifically, the amendment moves the reporting of stock options at fair value from the summary compensation table to the grants table in annual filings and requires that the summary table show only the value of options vesting in the current reporting period. So, for instance, if an executive receives a $10 million options package this year that vests over the next decade, the summary table will only report the amount to be expensed in 2007. Some see this as potentially distorting the value of these grants and impairing comparison because investors tend to focus on the summary table.

The CII would prefer that the fair value number appear in the summary table rather than the grants table. ‘That is where investors focus and the full measure of income will not be there,’ says Borrus. This latest change is certainly less than what the CII would have liked to see, she adds.

Randy Heron, an associate professor of finance at Indiana University, agrees that the total amount should appear in the main summary table. ‘The new method makes it more difficult for the unsophisticated investor to see the full magnitude of the options grant,’ says Heron, whose research on options backdating was one of the main catalysts leading the SEC to action this past summer.

Overall, however, Heron is satisfied with the amount of progress the SEC has made in pushing for better disclosure of executive compensation and doesn’t think shareholders will be led astray. ‘We have advanced far enough so that people will still be able to ascertain what executives are getting,’ he adds.

Presenting the full picture
The SEC explains that the change was made to better match compensation disclosures in annual reports and proxies with financial statements. Annual filings are now in line with FAS 123R, which calculates the value of equity awards over the period in which an employee is required to work in order to receive the award.

‘Under the July rules, grants given in the current year disappeared in the proxy,’ says SEC spokesman John Nester. ‘The commission recognized that there is interest in knowing what the company offered in the current period and is now giving both numbers.’

In terms of the dubious timing, coming the Friday before Christmas, Nester says the SEC wanted to ensure that the change was made in time for the current year-end reporting period, which marks the first time issuers are complying with new compensation disclosure rules. The reason for the lack of public consultation was because the amendment was unanimously approved. ‘There was really no reason for an open meeting,’ Nester adds.

Still, the commission is well aware of the controversy arising from its last-minute decision. On December 29, influential New York Times columnist Floyd Norris questioned the SEC’s judgment in rushing through this new reporting method. ‘The whole fiasco makes the SEC appear to have great difficulty understanding what it is doing,’ Norris wrote. But the commission feels much of the press has neglected to point out that both numbers are now reflected under the rule change.

‘There is no perfect representation of stock option value, but it is untrue to say both values [cumulative and current] aren’t represented under the change,’ explains Nester. ‘Some people are now saying the number everyone will focus on is the summary table and that the grants table number will be marginalized, while others suggest it could lead to double-counting.’

Just bad PR
Washington lawyer John Olson thinks the brouhaha surrounding the change is an overreaction. ‘Anyone who can do basic math can still get the information because it will all be in the proxy statement,’ says Olson, a partner at Gibson, Dunn & Crutcher. Congressman Frank has since backed down from his initial criticisms, claiming he now better understands the amendment.

Olson says the current proposal may have been on the table when the SEC passed new compensation disclosure rules in July but was inadvertently left out. ‘The issue was then raised internally by the commission’s division of corporation finance and its chief accountant,’ he points out. ‘Objectively you can find fault with the commission for not explaining what they were doing and not understanding that people might misconstrue the announcement.’

Corporate secretaries certainly didn’t misread the announcement. ‘It’s clearly more work for the legal department in drafting the compensation disclosure,’ says Noel Elfant, vice president, general counsel and corporate secretary at Zebra Technologies. Elfant, who was at work when the announcement came out, was unfazed by its timing. ‘I’m not surprised by anything anymore,’ he says, referring to the SEC’s penchant for rule changes.

‘A royal pain’
For the last six months, many general counsels and corporate secretaries have been in a blind panic to meet the SEC’s new compensation disclosure rules, which require companies to provide a much more detailed and segmented analysis of top executive and director pay. To prepare, corporate secretaries have been putting together mock compensation tables and drafting the compensation discussion and analysis.

‘If I were a corporate secretary who had been working for the last six months to get my compensation summary table ready and the SEC changed the way I had to disclose it on the Friday before Christmas, I would be furious,’ says Paul Hodgson, senior research associate at The Corporate Library. ‘It’s a royal pain in the neck.’

Elfant is in the midst of preparing his company’s proxy and agrees with Hodgson’s assessment. ‘Whenever there’s a rule change, you have to start crossing t’s and double-checking to make sure you are in compliance with what they are seeking,’ he says.

‘It’s definitely a lot of additional work,’ agrees Renee Seefried, senior vice president of Webster Financial Corporation’s regulatory group. ‘It won’t delay our filing, but it will take more hours to meet our normal deadline.’ With all the additional disclosure requirements this year, companies didn’t need this additional twist, she adds.

Different strokes
The amount of added legwork for corporate secretaries naturally varies by company size and structure. At smaller firms, where the role is often much more generalist, corporate secretaries are deeply involved in the minutiae of this change. But at larger companies, the function is often removed from the technical side of compensation reporting and the amendment is less onerous.

‘We are more segmented, so our company-benefits people focus on this more than the corporate secretary,’ reports Allan Resnick, divisional vice president of law and assistant secretary at Walgreens. ‘They have to get into the nitty-gritty of this, while we are responsible for making sure the whole thing is assembled.’

With an August 31 year-end, Walgreens won’t have to start focusing on the new disclosure rules until next summer. ‘We have some time to sit back and see what happens,’ Resnick notes. At the start of the proxy process, Resnick and his team will run an assessment to make sure the company is in line with new requirements. ‘What we do to comply might then change, but we tend to focus more on shareholder proposals and other items in preparing the proxy,’ he adds.

In theory, the new numbers for the summary table should already be calculated in the financial statements. But, in some cases, the financials are not yet ready and still have to be reviewed once prepared. ‘The whole exercise is painstaking with each options package needing to be rechecked to see which options are still vesting,’ says Hodgson. The process is further complicated by variables such as dividend rates and volatility, he adds.

Corporate secretaries also have to alert compensation committee members and work with them to approve the new tables. Most companies with a December 15 year-end had already prepared their compensation tables in line with the SEC’s original requirements, and many had already reviewed them with committee members. Now corporate secretaries have to rush to ensure that the revised tables are approved in time for the proxy deadline.

In Seefried’s case, her compensation committee had already seen a preliminary version of the company’s tables. She is now in the process of preparing an e-mail to explain the change to directors and setting up another meeting to review the new tables.

A wasted effort
It’s questionable as to whether all this revision at the final hour will make any difference in terms of the clarity of compensation disclosure. Resnick is in favor of any measure that promotes transparency, but doesn’t think the summary table amendment achieves this. ‘What these complex charts or graphs do is really another issue,’ he says.

The incessant focus on compensation disclosure is not reflective of what shareholders are interested in learning about, Resnick adds. He thinks investors are more concerned with return on equity and strategy execution than new changes to compensation disclosure. Elfant agrees that this new disclosure does nothing for corporate transparency. ‘It is my gut feeling that with so much information already out there, this doesn’t add much to the whole dialogue,’ he says.

Executive compensation has certainly become a radioactive issue following recent pay scandals at Home Depot and Pfizer, where departing chiefs each received golden parachutes of more than $180 million. But the media’s obsession with these outlandish pay packages may be creating an unhealthy fixation on compensation. ‘There have been really egregious cases [of compensation], but that does not represent the vast majority,’ says Resnick.

The controversy over options backdating, combined with overblown rewards, has created heightened concern among some investors over who is minding the store. But much of the potential for such excess has been quelled by the SEC’s July rules. ‘Before, people didn’t have enough information about pension plans based on accumulated benefits over a number of years and deferred compensation plans,’ says Olson. ‘But the new rules championed by chairman Cox have put a lot more transparency around compensation.’

Regardless of whether this revision was necessary, the only recourse for corporate secretaries is to begin doing the new calculations as soon as possible in order to meet one’s proxy deadline. As Seefried points out, the new calculations will inevitably result in more questions and further verification, so it’s important to get a head start.

For some corporate secretaries, there is a sense that this latest tweak is just part of an endless list of regulatory box ticking. ‘There may be some large institutional shareholders who can interpret and translate the change, but for retail shareholders this won’t have much effect,’ says Resnick. ‘My feeling is that, like Sarbanes-Oxley, we may be seeing a lot of resources being spent on something that doesn’t give a lot of bang for your buck.’

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