SEC Announces New Exec Compensation Rules

The new rules include greater depth of disclosure of the value of stock options, in the wake of the backdating options scandals (that's fraud, for those keeping score at home).

I'm of two minds on this. On the one hand, I understand and actively preach about the difference in productivity and organizational performance top leaders make. On the other hand, I'm of the studied belief that we don't actually reward leadership merit and performance as much as we reward loyalty and longevity among those of us with strong connections. We talk a good game about merit in our executive ranks, but we usually talk about it for other people, particularly the higher we are on the Fortune 500 ladder. Some of us are fat cats who desperately need a diet. We're not entitled to multi-million dollar incomes just because we've been around a while and have gone to the right schools.

This is from today's Wall Street Journal (online subscription required):

SEC Issues Rules
On Executive Pay,
Options Grants

Backdating Scandal Leads Agency
To Force Increased Disclosure;
Other Perks Will See Light of Day

By KARA SCANNELL and JOANN S. LUBLIN
July 27, 2006; Page C1

For the first time since the options-timing scandal mushroomed this year, federal regulators laid out requirements directing companies how to disclose their grants of stock options.

The new rules won't bar corporate boards from giving executives options at propitious times, but would instead shine a spotlight on such practices through increased disclosure. The guidelines are part of a sweeping overhaul to executive-pay disclosure the five-member Securities and Exchange Commission approved yesterday in a unanimous vote.

The rule takes effect in proxies filed by companies whose fiscal years end after Dec. 14. It will force companies to provide a total compensation figure for each of its top five executives. That number can be used to compare compensation across companies and industries.

SEC Chairman Christopher Cox has made revamping executive-pay disclosure a priority, so investors have a better handle on perquisites, deferred compensation and stock-option grants, payments that have been shrouded in fine print or not disclosed. To win the support of business groups, though, he has been careful to avoid the appearance of trying to set executive pay.

Some groups were hoping the SEC would go further, and had lobbied the SEC to require companies to give shareholders an advisory vote on executive pay.

"We're giving shareholders the information, but we're not giving them any power to take action on that information," said Richard Ferlauto, director of pension-investment policy for the American Federation of State, County and Municipal Employees in Washington. Investors, he added, haven't gained any power "to moderate pay that's not deserved."

[snip]

The SEC is investigating about 80 companies that may have "backdated" or timed the option grants to executives to benefit their payout. Options offer the right to buy stock at a specified "exercise" price, usually equal to the market price on the date the options were granted, so backdating them to a date when the price was low makes them potentially more valuable.

Last week, federal authorities filed civil and criminal securities-fraud charges against the former chief executive of Brocade Communications Systems Inc. and another executive, while a third faces civil charges. The three are accused of boosting the potential value of the options and concealing millions of dollars of compensation expenses from shareholders.

Companies will now be required to include a table with the value of the options on the date of the grant, and the closing market price on that day, if it is greater than the exercise price.

The reason for this table is to highlight any attempt by companies to give executives options priced below the value on the date they were granted. If there is any difference, companies will need to explain how they arrived at the exercise price. The murky disclosure on this topic is one issue that has arisen in the recent probes.

"As a result, compensation practices are going to change," predicted John Olson, a senior partner at Gibson, Dunn & Crutcher in Washington who advises corporate boards. "You will see fewer option grants, less out-of-cycle option grants and more careful monitoring by boards and compensation committees" of option usage, Mr. Olson said. SEC officials "are using a disclosure standard to impact corporate behavior."

For instance, he said, certain boards may restrict their CEOs' authority to dole out sizable option awards to new key employees below senior management, and increase board involvement in such decisions.

The intensified focus on option-award timing also may persuade more companies to take a tougher tack on when options can be given. They will have to disclose, for instance, whether management usually gets grants several weeks before the release of quarterly earnings.

"To the extent companies didn't have a formal policy in the past, they're going to have to have one, because investors will expect that," said Mark Borges, a former SEC official who now is a principal at Mercer Human Resource Consulting in Washington.

In addition to the option disclosures, the new rule will require companies to explain in plain English the rationale behind compensation decisions. They also will need to disclose pay incentives, unless a company can demonstrate the information is confidential or competitive.

And companies will have to disclose perquisites paid to executives if they exceed $10,000 in the aggregate. The rule will also call for the inclusion of two new tables, one to disclose pay to directors and another that would require the pension and retirement benefits owed to each of the five named executives.