Christopher Cox’s 2005 appointment as chairman of the Securities and Exchange Commission marked a move away from the tough regulation of the Enron era to a less confrontational relationship with Corporate America. But Cox’s time as chairman hasn’t been all that quiet. He’s overseen a big overhaul of rules stemming from the Sarbanes-Oxley Act of 2002. In December, he and the commission announced a revision to SEC rules regarding executive compensation. The revision now allows the value of stock grants to be spread over several years, rather than as one big grant. Options that vest in a particular year also have to be included in the compensation figure. The revision caused a stir. The Business Journal’s Jessica Lee tapped local lawyers for their views on Cox’s moves and his tenure as chairman.
How much of a setback, if at all, were Cox’s recent executive compensation reporting reforms?
Larry A. Cerutti
Partner,
Rutan & Tucker LLP, Costa Mesa
Given the fact that the executive compensation reporting reforms are embodied in a 436-page adopting release, it would be difficult to suggest that they are not both complicated and burdensome, especially with respect to smaller public companies that may not have the requisite internal resources to comply with the new disclosure requirements. This may be particularly true here in Orange County where small public companies constitute a significant percentage of the public companies located in the county.
Philip J. Koehler
Counsel,
Stradling Yocca Carlson & Roth, Newport Beach
On their face, the recent revisions to interim final rules previously released in 2006, which govern the reporting of stock and option awards in a public company’s proxy statements, demonstrates the SEC’s flexibility in considering public comment in the development of its final rules. Substantively, from an investor’s point of view, the revisions are commendable because they more closely align compensation disclosures for a company’s named executive officers with its financial statements, potentially eliminating a lot of confusion in reconciling the information from these two sources. However, these revisions reflect fundamental changes in the commission’s thinking and, because they are effective for the 2007 proxy season and annual reports plus registration statements filed after Dec. 15, 2006, the timing of the announcement couldn’t have been much worse. The revisions are effective immediately, yet the SEC may further amend the final rules at a later date based on additional public comment. This creates significant uncertainty in the preparation of a company’s proxy statement for 2007 and potentially a disconnect between its 2007 and 2008 filings. For example, the change to the compensation cost of stock awards and option awards based on rules published by the Financial Accounting Standards Board and whether or not the award was actually granted in that year, may cause a change in the identity of the officers whose compensation is subject to disclosure.
John C. Hueston
Partner,
Irell & Manella LLP, Newport Beach
I don’t believe that the recent executive compensation reporting reforms reflect much of a setback for businesses. In fact, as recently reported in CFO magazine’s November issue, most financial executives approve of the more transparent disclosures: “64% of financial executives said companies should explicitly report a postemployment agreement on compensation (that is, a golden parachute), and 58% said companies should explicitly report the dollar value of all noncash and nonstock compensation and benefits greater than $10,000. Only 18% said the SEC should not regulate disclosure of executive compensation.” This is likely because the new SEC rules are not intended to regulate compensation, but rather to bring more information to the marketplace. In the long run, I believe these reforms will benefit businesses. Unlike some of the other post-Enron reforms, the new executive compensation reporting requirements are not burdensome. Disclosure of this information will remove the appearance of backroom compensation deals by CEO cronies and likely reveal that most of the headline-grabbing executive compensation packages are in fact driven by market forces.
Amanda Paracuellos
Counsel,
Crowell & Moring LLP, Irvine
Despite the recent hype, the SEC’s announcement effected a technical, yet certainly welcome, modification to the sweeping new executive compensation disclosure rules released in August 2006. Namely, instead of being required to report the total value of a stock option grant in the year in which it is granted, companies will report the value over time only if and as the options vest and become exercisable. Business groups representing SEC reporting companies supported the as-modified version of the rule because it presents a more accurate and consistent picture of an executive’s compensation with value reported as it actually accrues to the executive. The modified rule also brings the compensation disclosure requirements for stock options in line with the financial reporting requirements. Shareholder activist groups supported the original rule and accuse the SEC of caving in to reporting companies who wanted to avoid having to disclose potentially eye-popping compensation amounts. However, even as modified, the new SEC rules still require disclosure of the full value of any given option grant in the year made, albeit in the less-prominent “Grants of Plan-Based Awards” table.
Mark Andrew Romeo
Partner,
Pillsbury Winthrop Shaw Pittman LLP, Costa Mesa
The recent amendment to permit public companies to report long-term equity compensation awards over the required service period for the compensation was not so much a setback as much as a recognition by the SEC that the reporting of the awards in SEC filings should be consistent with the way that the accounting rules report the awards. The value of the award will be reported over the required service period, or vesting period, rather than all at once.
Jim Scheinkman
Partner,
Snell & Wilmer LLP, Costa Mesa
I don’t view the changes in executive compensation reporting over the last year as a setback. The SEC has made changes to the way that reporting companies must disclose the compensation of their highest paid executive officers to provide greater clarity to investors. The compensation disclosure rules previously had not been significantly revised in approximately 15 years, and many believe it was time for an update. Many of the changes, such as providing bottom line total compensation numbers, greater information on perks, etc., will aid shareholders’ understanding of how the folks running their companies are being compensated. The SEC’s mission is not to determine how much companies can or should pay their top executives; rather its mission is to enable investors to be informed on matters important to an investment decision such as executive officer compensation. Whether the changes made in December (which require disclosure of the compensation cost of stock awards over the service period required to earn the awards, rather than disclosure in the year of the grant) can reasonably be argued either way. Disclosing the cost of the awards over the service period matches the way the company is required to expense the same awards. This approach matches the disclosures to the financial statements and, arguably, gives the shareholder a fairer comparison of the benefit the executives have brought to the company, as shown in the earnings, to the cost to the company, as shown in the annual expense.
Will his efforts be good for companies or burdensome?
Cerutti of Rutan & Tucker
While there may be a cost associated with his efforts, an honest and efficient market will benefit all companies.
Koehler of Stradling, Yocca
While executive compensation disclosure rules remain somewhat of a work in progress, on the whole, it would be difficult to find fault with the logic and purpose of the revisions.
Hueston of Irell & Manella
The new reporting requirements for stock and options costs add little administrative burden and more transparently reveal actual compensation costs. On the other hand, the enforcement efforts regarding historical backdating practices have caused many companies to spend millions of dollars on internal investigations and compliance efforts. With few exceptions, stockholders have mostly yawned at the revelations. To date, stockholders have not received much return on the costs of these investigations.
Paracuellos of Crowell & Moring
The most important effect of the new rules will be to change actual compensation practices. I expect many companies are in the process of rethinking both total compensation amounts as well as the various components of packages now that both the numbers and the policies will be open to public scrutiny. The new rules require customized, detailed disclosure in the new compensation discussion and analysis section including the reasoning, policies and strategies behind the various compensation packages provided to the executives. Many companies may use the compensation, discussion and analysis in 2007 as an opportunity to signal changes to their compensation policies on a going forward basis in order to offset disclosures of current or past compensation information that they fear may anger shareholders. The new rules also certainly bring with them additional administrative burdens of adjusting internal controls and processes to gather, analyze and report the required compensation data. We also expect that companies will expend significant effort on crafting the new Compensation Discussion and Analysis section, which will now be considered “filed” and not “furnished,” thus imposing upon companies and their CEOs and CFOs additional liability under the securities laws for inaccuracies in such disclosure. Indeed, we are advising our public company clients not to underestimate the additional time that this data gathering and analysis process could entail and to start preparing the new compensation sections of their 2007 proxies significantly earlier than in past years. However, after a few proxy seasons, disclosure procedures will have adjusted to the new requirements and for most companies will become a matter of course.
Romeo of Pillsbury, Winthrop
We have seen recent evidence that Cox and the SEC have been sensitive to the needs and concerns of smaller and newly-public companies. The SEC has reduced some of the reporting requirements under Section 404 of the Sarbanes-Oxley Act. That sensitivity suggests that the SEC will take a reasoned and balanced approach to the disclosure obligations of the companies while taking into account the concerns of investors. That is a good development for all parties in the longer term.
Scheinkman of Snell & Wilmer
I think his efforts will be positive. On the pro side, many people feel that the revised
disclosures will make proxy statements and the like more user friendly to investors. There will be some growing pains for companies and their advisers to get used to the revised disclosure requirements, but that is the case any time the SEC updates its disclosure regime.
Public companies were already subject to extensive disclosure requirements on executive compensation so these changes are not the equivalent of the new burdens imposed by the Rule 404 internal audit requirements and certain other Sarbanes-Oxley requirements.
How would you rate his handlings of the stock options issue?
Cerutti of Rutan & Tucker
Cox has done a great job in bringing to the forefront of the investing public the abuses involving the backdating of options and the SEC’s intolerance of these practices.
Koehler of Stradling, Yocca
Chairman Cox was handed a very difficult task early in his tenure. In the aftermath of the accounting scandals of recent years that spawned the Sarbanes-Oxley Act and its regulatory progeny, he has demonstrated considerable leadership and skill in managing the commission’s rule-making efforts, while balancing a complex array of competing interests. While this could have led to the appearance that the commission had assumed an adversarial posture vis a vis the issuer community, thus far it has not and Cox should be applauded for both his communication skills and managerial ability. The professionals who work with issuers in these areas have faced tight compliance deadlines and last minute regulatory fire drills before and we will no doubt overcome these challenges as well.
Hueston of Irell & Manella
Cox has approached the stock options issue on two levels: new rules for the disclosure of stock options as compensation and enforcement efforts directed at instances of stock options backdating. I give high marks for his new reporting requirements for the cost of stock and options awards. Cox’s late December amendment requires companies 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.” Previously, the rule required that companies report the costs all at once. Although critics of the most recent amendment have complained that stretching out the costs over time blurs the cost disclosure, such disclosure represents the actual annual cost and the total cost may still be found separately in the director compensation table. It is too early to rate Cox’s enforcement efforts regarding the backdating of stock options. Although few cases have been charged to date, Cox recently promised that many others were moving from the investigative to the charging stage. The investigations, largely targeting historic practices, have in most instances caused little concern to stockholders. There is no doubt that options backdating was once a widespread practice in Corporate America. The more difficult question is which executives should be targeted for civil sanctions and criminal prosecution from the over 150 companies that have backdating issues. If charged executives appear to have engaged in conduct lacking the traditional “badges of fraud” in SEC enforcement actions, the SEC will be subject to substantial and justifiable criticism.
Paracuellos of Crowell & Moring
While the timing and circumstances of the “surprise” December announcement have been somewhat unfortunate, overall I rate Cox’s performance as fair and balanced. Regulators were under significant pressure to make drastic and sweeping changes, given the rising tide of shareholder activism and general public outcry over ever-rising executive compensation packages and the more recent stock option “backdating” scandals. Cox responded by updating the 14-year-old compensation disclosure regime to provide the clear, meaningful and comprehensive compensation information demanded by investor and shareholder activist groups. At the same time, the final rules reflected SEC acceptance of many objections raised by reporting companies and business interest groups. For example, the SEC backed away from its initial suggestion to require extensive disclosure on up to three non-executive officers.
Romeo of Pillsbury, Winthrop
Cox has been trying to strike a balance between obtaining more information for the benefit of investors and not imposing excessively burdensome disclosure requirements on smaller companies that cannot afford to spend a lot of money on the disclosure requirements. That effort should be commended.
Scheinkman of Snell & Wilmer
I am generally a fan of Cox, and, contrary to the public statements of some politicians, I think he and the SEC handled itself well with the stock option compensation rules. It received more than 20,000 comments on its earlier proposed compensation rules, and responded to legitimate issues raised after an extensive deliberative process. As to the SEC’s enforcement activities on “option backdating,” and similar issues such as “option spring loading,” the jury is still out,figuratively and literally. There is a wide spectrum of reasons for option “misdating,” ranging from personal greed to sloppy paper handling in the processing of options to hundreds, if not thousands, of employees. Now that this issue has reared its head, companies and their advisers are developing best practices, which hopefully will be widely adopted in the industry. In picking its cases to bring enforcement proceedings, I hope the SEC separates the wheat from the chaff and only goes after those who intentionally misled the public.
