New SEC Comp Rules Aim To Please

THE NEW SEC HAS MANAGED TO please all its constituencies—at least for now. Its anxiously awaited decision on new compensation disclosure rules, issued on July 26, has won cautious approval from shareholder advocates and corporate leadership alike.

Not that compliance will be easy. Boards have their work cut out for them, especially compensation committees. Directors will not only have to make their own pay public, but they'll also have to provide far more detailed greater accounting for pay and perquisites. Perhaps most challenging, they will have to explain the logic behind their decisions. The new disclosure rules start taking effect at the end of this year and, for many companies, will require a wholesale remaking of the proxy statements due in the spring of 2007.

The SEC's action, following several years of scandals regarding pay, is the most sweeping move on compensation in 14 years. The agency spent six months debating and received more than 20,000 comment letters. Shareholder representatives are pleased with the results. "Much compensation has not been salient and has been hidden for a long time. Now it becomes clearly visible," says Lucian A. Bebchuk, director of the Program on Corporate Governance at Harvard Law School whose recent book, Pay Without Performance, critiques how companies compensate executives. "The SEC has done a very good job with extending disclosure requirements," he adds.

Among the major changes are ones requiring that a single figure be provided summing up all forms of an executive's pay; separate tables stating retirement benefits and deferred compensation; and reporting of perquisites valued at more than $10,000. For companies with market capitalization of more than $700 million, disclosure must be made of the pay and titles of the three highest-paid executives in decision- making capacities other than the top five executive officers. Companies must explain in easy-to-understand English why they are paying executives what they are.

In a move that surprised some, the SEC also is requiring that boards reveal how and when stock options are granted. The requirement comes at a time when at least 80 companies are being investigated for dating their stock options in ways that could give executives an unfair advantage. One faces civil and criminal charges regarding options backdating.

While the stock options reporting requirement has drawn some criticism, as have some other aspects of the SEC's decisions, the new rules have also won praise from corporate interests. "With respect to boards," says Thomas Lehner, director of public policy for the Business Roundtable, "one of the things that we'll see next year [is that] boards and directors will have a clearer picture of what's contained in executive compensation. It will help directors better evaluate executive compensation and understand what CEOs are being paid for."

In considering disclosure changes, the SEC walked a fine line between dictating how executives should be paid and allowing shareholders to be better informed. The commission managed the challenge successfully while raising "the importance of executive compensation decisions being grounded in strong business cases and rationale," says Russ Miller, senior client partner with Korn/Ferry International, an executive recruitment firm. "I've already been seeing this, and boards and directors are taking this very seriously."

The key tool for linking pay with business strategy is the requirement that proxy statements contain a new section that discusses the compensation committee's rationale behind pay decisions. Called the Compensation Discussion and Analysis, the section is supposed to state a corporation's goals and then show how pay decisions help in reaching them. Besides saddling boards and their compensation committees with extra work, the new section is loaded with potential controversy.

For one thing, under some circumstances the SEC can exempt companies from publishing the discussion section, or weaken the requirement. Compensation- related goals must be stated in only general terms, and a company might not be required to list them at all if it can demonstrate that doing so would put it at a competitive disadvantage. For example, a company whose next-year goal is to grow by acquiring a competitor might link its CEO's pay to how well he or she executes the acquisition. But revealing its target would clearly fly in the face of a company's best interests.

The worry is that some companies may interpret this "competitive disadvantage" provision in very loose ways. "The challenge," Miller says, "is balancing the needs to provide transparent information around business decisions and not putting the company in a compromised position vis-à-vis its competition. It is an imperfect situation because we can't satisfy both those things in all cases."

Lehner of the Business Roundtable agrees: "This is going to be a challenge, no question. It will take a couple of years for that language to be developed that satisfies the SEC but doesn't [improperly] reveal the strategic goals of the company."

The stock option part of the SEC's revisions also could be problematic, says Ken Raskin, a partner specializing in executive benefits law at White & Case in New York. Among other things, boards must now make certain that they closely track who actually grants stock options. "Sometimes awards are made without the proper delegation," he notes.

Lehner worries that the SEC hasn't spelled out stock options disclosure clearly enough, and he is still awaiting final details. His concern is that there may be duplication of data, since companies must disclose the options' grant date and value on that date, then subsequently their exercise date and value at exercise. "We don't want to make people think [the options] are being awarded twice," Lehner says.

Harvard's Bebchuk, for his part, thinks the SEC should have issued even stricter rules for stock options disclosure. "It is a breaking scandal," he says." He notes that boards could voluntarily have done some of what the SEC is now requiring.

But all in all, he praises the agency's work. "Directors are aware that their compensation decisions are going forward with significant attention, and they are going to be scrutinized by outsiders." For the time being, all sides seem content with that outcome.