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See also the following December 28, 2006 news reports:


New York Times, December 29, 2006 column


The New York Times

December 29, 2006

High & Low Finance

Does S.E.C. Know What It Is Doing?

Understanding executive compensation has never been easy for investors, and there is no shortage of consultants ready to help companies reward executives in ways that will not be fully understood by investors.

The disclosure plan adopted by the Securities and Exchange Commission in July was a major step forward. The most important features called for better reporting of retirement benefits and perks — the areas with the least disclosure under the old rules and, by no coincidence, the areas where the most creative ways of hiding compensation had been developed.

The plan included a carefully thought out summary table, of which the commission’s chairman, Christopher Cox, was proud. “There will now be one bottom line number, including all options, for an executive’s total compensation, and that number will be comparable from company to company,” he said then.

But now that comparability has been severely damaged by the commission, which chose to act without letting the public know it was even considering action — and therefore could not get help from the public in understanding the unintended consequences of what it was doing.

It is not clear whether the commissioners even understood the ramifications of what they agreed to in a decision that was released late last Friday. But the result is that identical pay packages given to two executives will be reported very differently, depending on the details of a company’s retirement plan. That would not have happened under the July rules.

Say the chief executive of American Widget gets a $24 million option grant on Dec. 1 of this year, with the options vesting — meaning they may be exercised — over four years. He is not eligible for retirement, perhaps because he joined the company only a few years ago, or perhaps because he has not reached the company’s minimum retirement age of 60.

In the summary table, the value of that option will be shown as $500,000. That is because he has worked just one month of the 48 months needed for the option to become fully exercisable.

Over at National Widget, American’s main competitor, the chief executive gets an inferior options package on the same day. It is worth $5 million, with the same four-year schedule. But that executive is eligible to retire, although he has no intention of doing so. The compensation summary will show he got a $5 million option.

The reality is that one man received options worth nearly five times what the other one was awarded. The appearance is very different.

This happens because the December rule says companies must follow the directives of the Financial Accounting Standards Board, which hinge on retirement status. The July rule, by contrast, called for putting the entire value of newly accounted options in the table, whether or not the executive could retire.

Companies usually let workers who retire — but not those who leave before retirement — keep their options. So the accountants figure there is no requirement they work any more, and treat the full value as instant compensation.

That makes sense to accountants, but when it comes to compensation disclosures, it runs counter to common sense. Both Widget executives will be able to cash in their options over four years, if the stocks rise.

When I talked to Mr. Cox about the new rule this week, he told me that the change was largely technical, and reflected what he had intended to do in July.

The commission disclosed what had happened then, in great detail. And when the rule was proposed last January, Mr. Cox himself helped to explain the very point he now says he did not know was in the rule.

“It was,” Mr. Cox told me, “a very long document. I did not realize until after it was approved that we had not fixed that point.”

Nor did he recall the details of the earlier conversation, which is available on the S.E.C.’s Web site.

When I asked whether he understood the anomaly created by the retirement-eligibility issue before the rule was changed, he did not say yes or no.

He rightly pointed out that there are anomalies with the earlier rule as well, because there was no provision in it to subtract the value of options that were forfeited. Now they will be subtracted, making severance packages appear lower.

It is a judgment call to say which rule is better. But there was no need at all to have to make this decision just before Christmas, rather than last summer. If the commission really did not know what it was doing then, that is an indictment of the staff work — or more precisely of the communication between the staff and the commissioners, because the staff explained it quite well to the public.

Under the new rule, some companies will be able to report lower executive compensation to the public in 2007 than would have been reported under the old rule. It will be more difficult to compare companies, and some executives will be left off the disclosure forms even though they were better paid than executives who are included.

And the whole fiasco makes the S.E.C. appear to have great difficulty understanding what it is doing.





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