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Apr 30, 2015

SEC’s proposed pay for performance rules seen as regressive

With outdated reliance on Total Shareholder Return, rules contradict SEC's efforts to broaden discussion of how company performance should determine executive pay    

The SEC’s newly proposed rules for disclosure of pay for performance, which the Commission discussed in an open meeting on April 29, would rely primarily on stock price movement as the measure of company performance, while pay would be limited to awards that have actually been paid in a given calendar year. The

If the rules -- mandated under the Dodd-Frank Act -- are implemented, they would require companies to make additional calculations because of how the required information differs from that currently provided in the summary compensation table (SCT) in the proxy statement.

The new definition of compensation would require backing out certain elements typically seen in the SCT, including equity awards that haven’t vested and any adjustments to pension values based on fluctuations in actuarial assumptions. Also, companies would use fair market value on the date of vesting for equity-based compensation instead of the estimated grant date fair market value that is used in the SCT.

The rules would also require reporting and comparing cumulative Total Shareholder Return for the last five fiscal years, as well as a comparison between the company’s TSR and that of a peer group. ‘TSR for the peer group has a discretionary element to it in the sense that a company can pick the peer group. So that’s somewhat helpful, but once you pick that peer group, you’re going to have to know what the TSR for the peer group is compared with your TSR,’ says Andrew Liazos, a partner in McDermott Will & Emery’s Boston office and head of its executive compensation practice.

To get around the rules and showcase performance as they see fit, Liazos says he expects bigger firms to disclose supplemental information that draws investors’ attention to performance metrics other than TSR that the company deems important.

‘I suspect the larger companies will do what’s required to comply with the rule, but then they’ll also give disclosures that they think are really relevant and useful because they want to get favorable say-on-pay votes,’ he says.

As an example of how the proposed regime doesn’t suit investors’ needs, Liazos points to a hypothetical pharmaceutical manufacturer early in its life cycle. ‘You’re going to need to pay some people good money to get them to come in, and they are probably going to get a fair amount of equity and the like. And it may take years before they actually hit the jackpot and get an FDA-approved drug,’ he says. At such a company, stockholders understand that getting a drug approved is what’s critical to the company’s success rather than how the stock performed in the last year, he explains.

In a comment on the Society of Corporate Secretaries and Governance Professionals’ Society Huddle discussion board, one member pointed to the apparent contradiction between the proposed rules and the SEC’s attempt in 2006 to eliminate the five-year TSR graph from the Compensation Discussion and Analysis in the belief that it was outdated.

‘Although the SEC accommodated investors who wanted the graph retained as a ready source of TSR information by requiring that it be presented in the annual report to shareholders, the SEC continued to believe that presenting the performance graph as compensation disclosure weakened the CD&A's objective to provide a broad discussion of the various elements of corporate performance that determine executive compensation,’ he wrote.

In an email to Corporate Secretary, the same Society member said that Congress, in enacting section 953(a) of the Dodd-Frank Act, mistakenly assumed a permanent correlation between executive pay and TSR. ‘That’s just not true unless a board’s compensation committee has decided to take it easy and design a comp plan that directly ties total direct compensation to TSR, ignoring strategic accomplishments, business goals (Ford investing in a new Ford F-150 at the expense of current year profits, which may reduce the stock price) or other metrics such as return on equity, earnings per share, or net revenues,’ he said.  He added that the new proposed rules just won’t work.

A 60-day comment period will begin once the proposed rules are published in the Federal Register. Liazos expects there to be numerous comments advocating that companies be permitted to use a number of different performance measures. He also expects some comments questioning whether the new disclosure will be worth all time and expense needed to implement it.

‘Whether these rules are going to find their way into actual disclosure one could say might have a lot to do with the elections in November next year,’ he says. ‘How quickly is the SEC going to be able to turn around that into a final rule, particularly if there are legislative proposals to repeal it?’

Liazos says he wouldn’t be surprised to see the SEC ultimately decide to focus instead on its other objectives.

David Bogoslaw

Associate Editor and Online features producer for Corporate Secretary