New SEC Pay Rule To Benefit Executives

SEC Chairman Christopher Cox called inflated executive pay as misleading as underreported pay,.
SEC Chairman Christopher Cox called inflated executive pay as misleading as underreported pay,. (By Lawrence Jackson -- Associated Press)
By David S. Hilzenrath
Washington Post Staff Writer
Thursday, December 28, 2006

The incoming chairman of the House Financial Services Committee suggested it was a Christmas present for corporate executives from the Securities and Exchange Commission.

But SEC Chairman Christopher Cox yesterday defended the agency's recent action to modify stock option disclosures, saying it "will provide the maximum clarity and consistency for investors."

On the Friday before Christmas, without advance notice or a public vote, the SEC announced an amendment that generally would make top executives' annual pay appear smaller than it otherwise would have.

The amendment, which represented an about-face from a requirement that the agency adopted in July, would change the way stock option grants are reflected in the main compensation table of companies' annual pay reports. This revision lets businesses spread the estimated value of those options over multiple years instead of reporting their full value in the year the options are awarded.

The U.S. Chamber of Commerce and accounting firms that work for public companies had advocated such an approach. But reaction from other quarters was critical.

"I didn't even know they had a chimney at the SEC, and then all of a sudden this came slipping down it," Rep. Barney Frank (D-Mass.), who is set to lead the Financial Services Committee, said in an interview.

"Backtracking by the SEC on this important matter of stock options reinforces my determination that Congress must act to deal with the problem of executive compensation," Frank said in a statement yesterday.

The change "will make it harder for investors to get a transparent picture of the magnitude and value of options being granted to corporate executives," said Lynn E. Turner, former chief accountant at the SEC and now head of research at Glass, Lewis & Co., an adviser to institutional investors.

The commissioners adopted the amendment Dec. 15, but the agency waited to announce it because the Office of Management and Budget did not approve the rule until Friday afternoon, SEC spokesman John Nester said yesterday.

The SEC action reflects the confusion and criticism that surround stock options, which have created great wealth for many executives and have been criticized as contributing to some of the worst corporate scandals. In recent months, many companies have been examining whether option grants were improperly backdated to maximize their value to executives, and some corporate chiefs have lost their jobs.

The SEC and the Justice Department have been conducting probes of options practices, and criminal charges have been filed against officials from two companies.

An option gives the holder the right to buy a share of stock at a set price. If the market price of the stock rises above that level, the holder can exercise the option at a profit. Option grants typically vest incrementally over a period of years.

Policymakers have long struggled to include some measure of option value in executive pay, because the ultimate value of options only becomes clear when they are exercised. They may end up being worthless, or worth much more than initially estimated.

In July, the SEC overhauled the rules for pay disclosures, requiring that companies show annual compensation totals for top executives that include full estimated values of option grants. The approach the SEC announced Friday would spread the value of the options over the vesting period, following the method companies must use to account for the cost of options on their financial statements.

"Artificially inflating executive pay, or reporting 'phantom' pay that will never be received, is just as misleading as routinely underreporting it," the SEC chairman said in a statement yesterday.

Estimates of the total value of option grants will not disappear from the pay disclosures. Rather, they are to appear in a separate chart from the summary compensation table.

"I don't see it as an effort [by] the commission to enable companies to hide the ball on the value of option grants," said John Olson of the law firm Gibson, Dunn & Crutcher, which represents business groups.

Federal law generally requires that the SEC to publish a rule 30 days before it takes effect, but there are exceptions. In this case, the SEC found that inviting 30 days of advance public comment would have been "impracticable, unnecessary and contrary to the public interest," partly because the disclosure rules it adopted in July kicked in Dec. 15.

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