Human Capital & Careers

The SEC Stirs the Pot on Executive Comp

The commission miffed politicians and investor groups by changing the reporting of stock options cost right before Christmas.
Cheryl RosenJanuary 4, 2007

Before the Securities and Exchange Commission announced an amendment to its new executive compensation rules at 5:15 PM on the Friday before Christmas Eve, it left Barney Frank out of the loop.

That might have been a big mistake. Frank, a Massachusetts Democrat who assumed chairmanship of the powerful House Financial Services Committee on Thursday, was clearly miffed that the commissioners failed to let him know about the change before it was made official. He also felt that he wasn’t the only one who would be irate. In the end, he said, “I think they just may not understand how greatly they have pissed off America over stock options.”

Indeed, the substance of the amendment, as well as the timing of its announcement, raised a few eyebrows. In its December 22 press release, the SEC stated that it wanted align the compensation-disclosure rules it had just passed in July more closely with Financial Accounting Standard No. 123R, Share-Based Payment. The FASB rule requires a company to report the costs of stock and option awards “over the period in which an employee is required to provide service in exchange for the award,” according to the release.

To be fair, there was a hefty amount of praise for the SEC’s amendment, which will become effective when it’s published in the Federal Register. The change will, in fact, enable companies to reveal the costs of awards listed in the Summary Compensation Table of proxy statements over the period during which the awards vest. Previously, companies were required to report those costs all at once.

Under the rules issued in July, for instance, a company granting a CFO $5 million worth of options that vest over five years would have to report the entire $5 million in proxy statements this year. In contrast, the new amendment stipulates that the company will be able to report $1 million a year in each of the next five years.

Like the compensation rules themselves, the amendment applies to proxy, information, and registration statements filed on or after December 15 and to forms 10-K and 10-KSB for fiscal years ending on or after December 15—in other words, immediately.

After the SEC’s announcement, Rep. Frank fired off a press release calling the “loosening” of reporting “regrettable both substantively and for not having been open to more public discussion.” He also promised that Congress would revisit the issue of executive compensation, which he thinks is now constrained only by “the self-restraint of top executives, a commodity that is apparently in insufficient supply.”

Frank told that while “there’s no perfect answer” to the question of how to report stock option awards, “given the sensitivity to the excessive pay of executives and the recent shenanigans about stock options,” it’s better to err on the side of more disclosure than less.

But does reporting the cost of option awards all at once provide a clearer picture than reporting it over the time in which the options vest? On that question, opinion seems divided—or sometimes neutral. “I don’t think one answer or the other necessarily provides more complete or fuller disclosure—they’re just two different ways of providing the information,” said Scott Taub, the SEC’s deputy chief accountant.

Critics of the move, however, argued that stretching out the recognition over time would blur the reporting considerably. Listing the cost of options granted today over the next five years undermines the very purpose of the proxy statement, which is to tell shareholders clearly how much executives are being paid, said Amy Boris, deputy director of the Council of Institutional Investors. “It doesn’t tell you clearly what the compensation committee was thinking; it doesn’t clearly tell you up front how much they awarded the CEO,” she asserted.

Further, reporting the options cost over time is “inconsistent with the general rules of financial disclosure, where you match the charges against the period in which the charges are granted,” said Ralph DeMartino, vice chair of the securities practice group of the Cozen, O’Connor law firm in Washington. Stretching out the reporting of the grant over five years “sort of softens the disclosure,” he noted.

Another problem with that method of reporting is that options differ from regular compensation in that they’re not a sure thing. If the CEO leaves—as CEOs are wont to do in far less than five years—he or she wouldn’t get the full amount, he said.

But DeMartino, echoing the ambivalence of a number of observers, also said that “overstating compensation in the current period is equally troublesome, and less than transparent as well.” To some, however, the SEC’s amendment was squarely on target. The commission’s press release, for instance, “seems to make sense to me,” said FASB chair Robert Herz, noting that it produced a net gain in terms of disclosure.

Other advocates blamed the press for negative responses to the amendment. “This story has been badly reported,” said Carl Weinberg, a principal of PricewaterhouseCoopers’ global HR services practice. “It’s been reported as a way for companies to report less compensation, and that’s not accurate and very misleading.”

Besides including a mandate to list the full cost of stock options, the amendment also requires companies to record options granted in the past few years that are still vesting, he noted. For example, if $5 million worth of options are vesting over the five years from 2003 to 2007, the company would have to list $1 million of that figure in the current proxy statement.

But the SEC seems to have brought on some of the flak by the timing of the delivery of its message. The SEC “pushed this through the last day before Christmas—that tells you something right there,” Boris said. “Now it’s a fait accompli, because even though there’s a comment period, [the rule] takes effect right away.” The Council of Institutional Investors will be sending comment letters critical of the change, she noted, “and so will some other large shareowners.”

Yet even the SEC’s haste had its supporters. The commission’s decision to push out its change as close to December 15 as possible made a great deal of sense, according to Weinberg. “A lot of companies are actively working on their new proxies and if there was going to be a change in the rules, it was important to get it out quickly as possible,” he added.