Risk & Compliance

SEC’s Proposed Comp Rules Are of Little Use, Attorneys Say

Critcism is leveled at the proposed reporting framework's inflexibility and naive simplicity.
David McCannApril 30, 2015
SEC’s Proposed Comp Rules Are of Little Use, Attorneys Say

The Securities and Exchange Commission’s proposed new rules for the reporting of executive compensation by public companies, released Wednesday, put some questions on the table. Perhaps none is more to the point than simply: Why?

Executive compensation experts who spoke with CFO were critical of the particulars of the proposal, which aims to satisfy a requirement of the Dodd-Frank Act, and suggested that from a practical standpoint it won’t have much impact. Here are some of the key elements:

Pay for Performance

For the first time, companies would be required to demonstrate in their annual proxy statements the relationship between executive pay and performance. “Performance” is defined as total shareholder return (TSR) for the prior five fiscal years for large reporting companies (those with more than $75 million in public float) and three years for smaller issuers. “Emerging growth companies,” or those that have been public for up to five years, depending on sales volume, would be exempt from the requirement.

Barney Frank and Christopher Dodd, second and third from left

Barney Frank and Christopher Dodd, second and third from left, with President Obama.

Companies would also compare their TSR with TSR data on a peer group of five other companies in the same industry. The SEC would grant companies the right to choose their peer group.

Some public companies have been disclosing pay-for-performance metrics since 2011. That was the year following the passage of Dodd-Frank, which allowed for a nonbinding shareholder “say on pay” vote. According to Towers Watson, among 2015 proxies filed by Fortune 500 companies through April 29, just 27% disclosed a pay-performance relationship.

Among those that have done so, the metrics have been quite varied, but if the proposed rule changes become final following a 60-day comment period, companies would have to use the comparison to TSR, although they could, and presumably would, show additional metrics as well.

The five-year look-back period is significant, as companies have generally compared pay with performance for only the fiscal year prior to a proxy statement.

Unvested Equity

Companies would no longer have to report unvested equity awards as compensation. The applicable Dodd-Frank provision instructed the SEC to create rules for reporting compensation “actually paid.” Under the proposal, equity awards are to be reported in the proxy covering the year when they vest. Until now, companies have had to report the value of equity awards as of their grant dates.

New Reporting Format

Companies would report all elements of executive compensation in a new table replacing the existing Summary Compensation Table. As the SEC noted in its proposed rulemaking, “The highly formatted and specific approach [of the Summary Compensation Table] had led some to suggest that items that did not fit squarely within a ‘box’ specified by the rules need not have been disclosed.”

The table also would have to show a single figure for total compensation that includes all elements of compensation, a new requirement. “Because the tables did not call for a single figure for total compensation,” the SEC wrote, “that information had generally not been provided … although there had been considerable commentary indicating that a single total figure is high on the list of information that some investors wish to have.”

While companies were hoping for some flexibility in how to report compensation and demonstrate the pay-for-performance relationship, the SEC’s proposal is highly prescriptive.

No CFO Pay Breakout

Instead of reporting compensation individually for the CEO, CFO, and the other three most highly compensated officers, which is the current practice, companies would make two presentations: one with information on the CEO and the other with information on the average of the other four named officers.

In its press release, the SEC said the proposed rules “would provide greater transparency and allow shareholders to be better informed when they vote to elect directors and in connection with advisory votes on executive compensation.”

Will Anything Important Really Change?

Compensation attorneys who spoke with CFO are having none of that. At most, they suggest, the new presentation could have some value for individual investors.

But the approach to evaluating executive compensation already used by Institutional Shareholder Services, the dominant proxy advisory firm for institutional investors, is “significantly more robust and sophisticated than this disclosure requirement,” says Andrew Liazos, a partner and head of the executive compensation practice at McDermott Will & Emery.

“And even when there’s a quantitative fail in terms of TSR, ISS does a qualitative analysis of other mitigating factors. How much is this new rule going to change things? There’s a lot of question as to whether it’s really going to be worth all the effort.”

Mandating that TSR be the pay-for-performance measuring stick for all companies makes no sense, Liazos contends. “For example, I would look at a pharmaceutical company trying to get through Stage 3 testing for a drug it’s developing much differently than a company that makes widgets,” he says. “It’s all make or break in terms of whether that drug gets approved by the FDA so the company can start selling it. I don’t really care about TSR.”

Liazos also notes that there’s a lot of nuance in a typical executive compensation program that can’t be conveyed through the prescriptive tabular approach and by presenting a single total compensation figure.

“If you have to use a standard format, people are just going to pull numbers, because all they have to do is divide one number by another,” he says. “Here’s the headline in the paper: this particular CEO has the worst relationship between pay and performance. It’s not hard to predict that publications will rate executives on that basis. Companies are obviously very fearful of that.”

Steve Seelig, executive compensation counsel for consulting firm Towers Watson, notes that many existing compensation programs don’t take TSR into account at all.

“Even if TSR is important to them, other metrics might be just as important,” he says. “It’s rarely the case that companies use TSR as the sole measure of performance. It’s usually an amalgam of things. It’s very possible that in a year when the CEO gets paid well the TSR is flat, simply because the plans that were in place paid him to drive other metrics. So I think you’re going to see a lot of varied supplemental disclosures.”

Both attorneys note, though, that the SEC was constrained by the wording of the Dodd-Frank provision, which called for the pay-performance relationship to be based on the value of stock ownership.

On the plus side, Seelig opines that counting equity awards as compensation based on their value in the year they vest, as the SEC proposes, rather than when they were granted, is an improvement. It provides a better indication of what an executive has earned for a particular time period than the Summary Compensation Table does, he says.

Regardless, Liazos says he expects there will be a lot of pushback from issuers on the inflexibility of the proposed rule, and that there will be attempts in Congress to repeal the Dodd-Frank provision that triggered the proposal.

“Tell me how the elections come out in 2016 and I’ll tell you the likelihood that we’ll actually see these rules implemented and [used],” he says.

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