By
FLOYD NORRIS
The Securities and
Exchange Commission, in a move announced late on the last business day
before Christmas, reversed a decision it had made in July and adopted a
rule that would allow many companies to report significantly lower total
compensation for top executives.
The change in the way
grants of stock options are to be explained to investors is a victory for
corporations that had opposed the rule when it was issued in July, and a
defeat for institutional investors that had backed the S.E.C.’s original
rule.
“It was a holiday present
to corporate America,” Ann Yerger, the executive director of the Council
of Institutional Investors, said yesterday. “It will certainly make the
numbers look smaller in 2007 than they would otherwise have looked.”
Christopher Cox, the
commission chairman, said yesterday that he viewed the decision as “a
relative technicality” that improved the rule. When the rule was adopted
in July, Mr. Cox said it was aimed at providing information that would
allow shareholders to “make better decisions about the appropriate amount
to pay the men and women entrusted with running their companies.”
In announcing the new rule
on Friday, he said “the new disclosure requirements will be easier for
companies to prepare and for investors to understand.”
As controversy has grown
over rising executive pay, it has been hard to even get agreement on the
total value of compensation for top executives. The rules passed last
summer required companies to disclose more information and to compile it
in a summary compensation table that is expected to become the standard by
which corporate pay is compared.
The new rule changes the
way grants of stock options will be measured in that summary table.
Under the old rule, if a
company awarded an options grant valued at $15 million to an executive
this year, the full amount of $15 million would show up in the summary
compensation table.
Under the new rule, which
takes effect immediately, the amount reflected in the table would be much
smaller, with the remaining part of the $15 million included in later
years, as the executive qualifies to exercise the options.
Under some circumstances,
the options grant might not be reported at all in the first year, even if
the executive would otherwise have been the company’s highest paid
executive had the full value of the option grant been included.
The new rule is
intended to make the disclosures identical to the way companies report
options expenses in their financial statements, under accounting standard
123R, as approved by the
Financial Accounting Standards Board.
In an interview yesterday,
Mr. Cox said the change reflected what the commission had intended to do
when it adopted the original rule in July. “My understanding all along was
that we were going to follow the 123R model,” he said. “It came out
differently from that when we adopted it.”
The fact it came out
differently was disclosed by the S.E.C. at the time. The commission
pointed out that some companies had wanted to time the disclosures in
accordance with the accounting rule, but said the other approach “is more
consistent with the purpose of executive compensation disclosure.”
But on Friday, the S.E.C.
said it now believed that the change would provide “a fuller and more
useful picture of executive compensation than our recently adopted rules.”
While practices vary,
stock options often vest — meaning they may be exercised — over a period
of three to five years after they are granted. The options can be canceled
if the employee leaves the company before they vest.
For most executives, the
accounting rule says the expense should be spread over the period from the
grant to full vesting. So if options vest over five years, the expense
would be reported over that period.
In the $15 million
example, if the options vested over a five-year period, the summary
compensation table would reflect a cost of $3 million per year. In the
first year, the cost might be lower if the options were issued relatively
late in the year, and could be almost nothing if they were issued just
before the end of the company’s fiscal year.
But the new rule could
create confusion because it would treat options issued to some executives
— those eligible for retirement — differently.
If an executive were
eligible to retire when the option was granted, and could keep the option
if he or she did retire, then the entire option grant would be expensed
immediately and listed in the summary table in the year it was granted.
But if the executive is
not eligible for retirement, then the expense is spread out over the
several years it takes for the options to vest.
That makes it possible
that two executives with identical pay packages would have very different
disclosures, making the one eligible for retirement seem to be much better
compensated. “This will muddy the waters,” Ms. Yerger said.
Asked about that, Mr. Cox
conceded it was an anomaly. But he said there were anomalies under the
other rule as well. John White, the director of the commission’s division
of corporation finance, pointed to the fact that the rule adopted in July
could lead to reporting of compensation that would never be received.
“The anomaly that the
commission was most concerned with was that if an executive leaves the
company before the options vest, the full amount of the option still was
reported in compensation disclosure when, in fact, nothing was received,”
said Mr. White, who became director of the division in March, after the
previous rules were proposed but before they were adopted.
He said that some
companies issued options that had so-called cliff-vesting, in which all
options vested after five years, and were forfeited if the executive left
before that time. Under the new rule, expenses would still be reported for
the first years, but then a negative amount would be reported in the year
the executive left, reversing the earlier reported figures. There was no
such reversal in the July rules.
The commission adopted the
new rule in an unusual way, making it take effect immediately even though
the commission had not announced that it was considering a change and had
not sought public comment.
An S.E.C. spokesman
pointed to two other rules adopted that way in recent years. Both were
intended to comply with new federal laws that were about to take effect.
One, in 2000, stated that
e-mail messages from mutual funds could satisfy rules requiring that
information be given to customers in writing. The other, in 2001,
established rules for complying with the Gramm-Leach-Bliley Act allowing
mergers of financial companies.
Mr. Cox said there was no
time to seek comment if the change announced Friday was to take effect in
time to affect proxies issued in coming months. He said it would be
confusing if companies reported one way in 2007 and then changed in 2008.
The rules adopted in July
were intended to deal with widespread complaints that it was difficult to
discover all elements of pay packages for top executives. Besides
providing the summary table, the disclosures will provide new information
in a number of areas, including retirement benefits.
The disclosures will be
made for a company’s chief executive, chief financial officer and the
three other highest paid executives, as indicated by the summary table.
For those on the list, all option grants will be disclosed, so even if the
summary table leaves out much of the value of options granted to a chief
executive, investors could see the terms of the grant and consider it in
assessing how well the executive was paid.
Under the July rule, a
large options grant to an executive could propel him or her onto the
disclosure list. But under the rule adopted Friday, such a grant might not
put the executive in that group, meaning there would be no disclosure of
that executive’s pay that year.
Over time, of course, most
executives whose pay is being disclosed would have the same total reported
under either rule. Under the new rule, options that were granted in prior
years, but vested in 2006, will show up in next spring’s disclosures.
The reduction in reported
pay is likely to be the largest at companies that accelerated the vesting
of options in 2005 to avoid reporting them as an expense at all when the
new accounting rule went into effect. Executives at those companies will
not have as many old options vesting as they normally would have, and thus
will be able to report lower pay.
The commission said it
would take public comments on the latest change for 30 days, but it added
that the new rules were now final.
When the commission
considered the issue earlier this year, David C. Chavern, a vice president
of the United States Chamber of Commerce, urged it to take the step it
rejected in July and adopted on Friday, saying that to do otherwise would
overstate compensation, since options would not have been earned when they
were reported, and might later be canceled.
Whenever the value of the
options shows up in the summary table, the value shown will be the
estimated value of the option at the time it was granted. Years later,
when the options vest, the stock price could be much higher or lower than
it was when the option was issued, making the options much more valuable —
or all but worthless — by the time they show up in the summary
compensation table at the old value.
