Exploring Corporate Governance Around the World

By Allison Garrett, Senior Vice President for Academic Affairs at Oklahoma Christian University

Wednesday, July 26, 2006

SEC Adopts Proposed Executive Compensation Reforms

The SEC had an open meeting earlier today to discuss the compensation proposals made in January. The press release announcing passage of the proposals is here. The open meeting was held via webcast and you can listen to the meeting by clicking through the link provided by the SEC here. Tabled for now are the rules relating to disclosure of compensation for highly-compensated employees who are not executive officers.

Below are highlights of the meeting:

1. The SEC voted to adopt the proposals, with a few modifications based on the 20,000+ comments received.
-- Highlights include the new compensation disclosure and analysis section which will be filed and is therefore subject to the CEO and CFO certifications. Companies must disclose practices including any spring loading or use of strike prices other than FMV. Companies must discuss and analyze in CDA. The SEC will provide a list of questions companies should consider addressing in the CDA. I think that having the CDA filed instead of furnished and subjecting it to the CEO and CFO certifications is short-sighted. The result is that directors who are compensation committee members may be asked to provide sub-certifications to the CEO and CFO and this turns on its head the appropriate reporting relationship between the CEO and the board. In addition, a weird result of the rule is that the people who are supposed to set compensation policy and describe the rationale behind it probably won't be the people writing the CDA. Instead, it will be the people affected by the policies. 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. Good governance practices require limited involvement of the CEO in compensation processes (at least as to him and any other executives who are also directors), making it surprising that the SEC would take this approach.
-- A new brief compensation committee report will be furnished and will appear over the names of the compensation committee members.
-- The SEC had recommended that the performance graph be eliminated, but the SEC has decided to keep the performance graph, but move it into the annual report, rather than including it in the proxy statement with compensation information.
-- The new proposals will provide for a single total compensation number. This will be reflected in the Summary Compensation Table, which will include compensatoin under non-equity incentive plans, the dollar value of stock and options under FAS 123R, annual change in actuarial present value on pension benefits and deferred compensation, and all other comp not reported in other columns (including perquisites greater than $10,000, with the SEC to provide interpretive guidance regarding what a perquisite is).
-- With respect to option grants, there will be tabular presentation. To address the backdating issue, the SEC will require that the closing price on the grant date be disclosed if it exceeds the strike price and the date the committee acted if different than the grant date.
-- With respect to performance targets under incentive plans, the SEC took into account the comment letters expressing concern that disclosure of some targets may result in the disclosure of competitively sensitive information. The SEC will allow a confidential treatment request to avoid disclosure of competitively sensitive information.
-- The new pension benefits table will include the actuarial PV of accumulated amounts for each executive officer. The same assumptions and measurements as for financial statement reporting purposes will be used. Estimates will be made based on current compensation.
-- New narrative disclosure of severance and change-in-control arrangments will be required and will include an estimated range of amounts payable. Amounts will be calculated based on the assumption that the triggering event took place on the last date of the FY.
-- A director compensation table similar to the summary compensation table for executive officers will be required.
-- Related party transaction disclosure was adopted substantially as proposed, with an increased threshhold for disclosure of $120,000. Companies must disclose their procedures for review or approval of RPTs.
-- The SEC has consolidated and updated director indepence disclosures under Item 407. Companies will be allowed to group by category RPTs that are not otherwise disclosed.
-- The SEC emphasized the need for companies to write their disclosure in plain English that may be easily understood by lay readers.

2. The proposal regarding providing compensation information for up to 3 other highly-paid employees has been tabled for now. It will be reproposed, with several modifications. The individuals about whom such disclosure must be made must have some sort of significant policy making function, either at the parent company or a principal subsidiary or business segment. This means that professional atheletes, salespeople, entertainment personalities and investment professionals would not be covered by the reporting requirement unless they have these other types of responsibilities. Further, the reporting would only apply to large filers.

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