Proxy Changes Coming

Proxy Changes Coming
In a 137-page release of proposed proxy rules, the SEC is seeking comment on increased disclosure requirements about the potential incentivization of risky behavior. The proposal also would change the way stock options are reported, include more disclosure about board members and board structure, and add transparency to potential consultant conflicts-of-interest. By Anne Freedman
The Securities and Exchange Commission's 137-page rules proposal relating to disclosures about executive compensation, risk management and board structure includes some long-anticipated changes as well as some surprises. The proposed changes -- expected to go into effect for the 2010 proxy season -- allow companies to revert back to the prior, simpler way of disclosing the value of stock-option grants, increase disclosure related to potential consultant conflicts-of-interest as well as potential incentivization of risky behavior, and require enhanced information about the qualifications of board directors and nominees as well as the structure of board leadership. "The turmoil in the markets during the past 18 months has reinforced the importance of enhancing transparency, especially with regard to activities that materially contribute to a company's risk profile," according to the SEC's proposed rule. Some of the proposed disclosure rules -- such as including information on potential conflicts of interest by compensation consultants -- had been telegraphed far in advance of the July 10 release. A 60-day comment period will ensue, prior to the SEC adopting final regulations. "I think what's really new there, is [the SEC is] now requiring disclosure below the executive level of compensation programs if they are material to the whole organization," says Irving Becker, Hay Group's national practice leader for executive compensation, based in the Jersey City, N.J., office. "I guess this will be a real challenge for the companies that have many different business units and where the compensation programs [in each unit] are different," he says. "That is definitely new and it will highlight and put pressure on companies to really take a new look at those programs." That initiative, says Scott Olsen, principal in PricewaterhouseCoopers HR Services Practice in New York, is slightly different, but "thematically consistent," with the requirement already promulgated for companies that accepted TARP funds from the government as part of the bailout. The SEC proposes that companies provide an "explicit discussion" -- but not a tabular disclosure -- of the relationship between a company's compensation policies and the way those policies may create incentives that affect "excessive and unnecessary risk" that may have a "material effect on a company," he says. That's a good thing, says Charles G. Tharp, executive vice president for policy of the Center on Executive Compensation, which is part of the HR Policy Association, a Washington-based membership organization of large company HR leaders. "We support the disclosure," he says, adding that he believes many companies have already reviewed their compensation plans "so they don't motivate or incent aggressively risky behavior." While seemingly aimed at financial institutions, such disclosure could include a wide range of employee-incentive plans in large organizations that have various business units, experts say. Don Lindner, executive compensation practice leader for WorldatWork in Scottsdale, Ariz., says the proposed requirement is "very nebulous" and could create difficulties for HR leaders and other company officials attempting "to determine excessive risk and how do you measure that in different situations?" In general, though, he says, companies should already be doing such tests on a consistent basis. "Looking at executive-comp plans and what you are incenting and how you are incenting and how you may be affecting employee behavior should always be a part of the design and testing of incentive plans," Lindner says. One potential unintended consequence of the proposed rule, Becker says, is that companies may opt to make all of their incentive plans similar instead of tailoring incentives to individual business units and the risks in each business unit. "I worry that companies will say, 'Gee, we need to have the same program for everybody,' and that may really not be in the best interests of the organization long term," he says. The proposed enhanced disclosures about the qualifications of board directors and nominees to the board may result in upgraded talent on board comp committees -- maybe even leading to more HR leaders being asked to join boards in such a capacity, Tharp says. And the disclosure related to board structure -- whether one person or two serves as the company CEO and board chairman -- may "challenge companies to really think through that issue," Becker says. The other major change will simplify reporting of stock-option or restricted-stock grants, by eliminating the need to amortize the grants and allowing companies to report the full grant date fair value of equity awards. "What the SEC is acknowledging," says Olsen, "is that the approach they took in December 2006 [when they set up the current formula for valuation and disclosure of stock option and equity awards] added complexity" to the process. "This [proposed rule] creates a better alignment between the way decisions are made and the way they are going to be reported," he says. At the same time, Tharp says, the SEC missed an opportunity to fix a "flawed model." "They improved a wrong model but they missed an opportunity, unfortunately, to change the model to focus on what [the executive] actually made. ... They missed an opportunity to start talking about actual pay. They are still talking about the accounting expense of potential pay." As for the disclosure about potential conflicts of interest related to compensation consultants, "I think the chief human resource officer, many are all over this and already have been," Tharp says, noting that many boards already hire their own independent comp consultants. Andrew Katsoudas, director of the HR Practice for PwC in Chicago, agreed the increased disclosure requirement for that was not a surprise to most observers. "They have been telling us since June that they were going to do this," he says.
July 14, 2009
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