Business Gifts

Just in time for the 2007 proxy season, the U.S. Securities and Exchange Commission came up with a big bag of Christmas presents for the business community. On Dec. 13, the commission loosened Section 404 for the Sarbanes-Oxley Act by giving more say in what constitutes “material” information. A few days later, the Public Company Accounting Oversight Board lightened up on a similar section of its rules overseeing auditing firms.

And on Dec. 22 came the biggest and most controversial gift of all. The SEC unexpectedly reversed its position on how stock option awards must be disclosed in the new summary compensation tables that will be required in this year’s proxy statements. Companies will be allowed to account for the options’ annual cost to the corporation rather than stating their full amount over several years. The decision means that the single executive pay number that shareholders behold will in many cases be considerably smaller than it would otherwise have been.

Some observers saw the move as a retreat in SEC Chairman Christopher Cox’s 2006 crusade to make executive compensation disclosure more transparent. Many remarked on its timing, designed to escape media notice after much behind-the-scenes lobbying by corporate groups such as the Business Roundtable and the U.S. Chamber of Commerce. The comment period was also unusually short.

An angry Barney Frank, the Massachusetts Democrat who is the incoming chairman of the House Financial Services Committee, denounced the SEC move as “backtracking” and called for more direct congressional oversight of executive compensation. Institutional investor groups were likewise piqued. ”We’re disappointed that this is a step back from what the SEC intended to do on full disclosure,” said Amy Borrus, deputy director of the Council of Institutional Investors in Washington.

But business groups had been pushing for the SEC action on stock options. Their rationale, according to executive compensation author Bruce Ellig, is that it makes more sense to account for options according to their actual expense during the audit year rather than by total compensation to the executive if they are exercised.

For example, says Ellig, a company may grant options worth $100 million to an executive over a typical five-year period. Rather than report the full $100 million amount in the year of the grant, the company may report only each $20 million increment each year over the five years as its expense. “Sometimes options are not exercised at the full value,” says Ellig. “If the full amount is accounted for as an expense, some think it might be misleading.”

Doing it this way, however, gives investors an incomplete picture of how the company values executives. One remedy suggested by Ellig, a former Pfizer executive and adviser to its compensation committee who wrote The Complete Guide to Executive Compensation, would be to require a footnote or separate table making the full value of the stock options clear. Borrus notes that the SEC already imposed such a requirement last summer. But she says that investors have to hunt harder to find the total.

For companies, the rules will probably simplify reporting this season. According to the Dec. 13 decision, executives will settle the question of what is a “material” risk and concentrate auditors’ attention on those issues, thus saving time and money. Until then, the SEC had not provided guidance on how audits should be conducted, leaving executives and directors to rely on the accounting industry’s advice. That left many companies “at the pecuniary mercy of the accounting industry,” said Commissioner Paul Atkins.

Critics, however, say that the actions don’t go far enough to explain what needs to be audited and what does not. “I am generally disappointed with the SEC’s guidance,” says Richard Swanson, a law partner specializing in securities litigation and enforcement at Arnold & Porter in New York. “It’s too amorphous and leaves too much judgment for auditors who will continue to audit out of fear. That means more expense.”

As for options accounting, observers say the SEC will revisit its Dec. 22 decision later this year, after the spring annual meetings. are over. But will Cox will take back some of his holiday largesse? Or will this turn out to be the gift that keeps on giving?