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Investors’ Comment Letters Make Case for Strong Pay-for-Performance Rule

The SEC plans to propose by the end of 2014 a rule that will require public companies to provide more details about the relationship between executive compensation and a company’s financial performance. Some investor groups want the market regulator to write a regulation that’s strict enough to stop companies from understating executive pay.

The trade group for pension funds and the country’s largest labor union recently asked the SEC to write strong disclosure requirements for the relationship between executive compensation and company performance.

The rule is mandated by the Dodd-Frank Act, and the SEC is planning to issue a proposal by the end of 2014.

Writing separately to the SEC, the AFL-CIO and the Council of Institutional Investors (CII) said pay-for-performance data should supplement, not alter, the summary compensation table in an annual proxy statement required by Item 402 of Regulation S-K.

The table shows current compensation over a three-year period for the top five executive officers, which investors rely on to cast say-on-pay votes as well as for director elections.

The summary table makes it easy to compare compensation between companies, wrote Heather Slavkin Corzo, director of the AFL-CIO’s Office of Investment, in an August 8, 2014, letter. The table provides investors with a summary of current compensation a top executive accrued over the fiscal year.

It’s important to get full and transparent compensation information, wrote CII General Counsel Jeff Mahoney, in an August 6 letter to Keith Higgins, director of the SEC’s Division of Corporation Finance. The letter was sent as a follow-up to a July 1 meeting.

Mahoney proposed that at a minimum, the rule should require two graphic representations of pay-for-performance information. One would be for the CEO, and the other would aggregate the compensation for a company’s five most senior executives.

Mahoney said the disclosures should be made at least once every five years. Among other things, when the executive has been in the same position for more than five years, the council believes it’s helpful for investors to see the compensation for the entire service period.

The AFL-CIO and CII both said the SEC should resist calls by some companies to adopt a “realized pay” approach to satisfy the provision’s language that calls for disclosure of the “executive compensation actually paid.”

The AFL-CIO’s Corzo said that at first glance, a “realized pay” approach sounds attractive, but it’s flawed.

“Realized pay” calculations include the value of stock options, but the year that a stock option is exercised doesn’t match the performance period during which the option was earned, Corzo said.

“In effect, including option exercises in executive pay calculations conflates changes in an executive’s liquid wealth with their income,” Corzo wrote. “Such disclosure may also understate executive pay as many stock options are exercised after an executive’s termination.”

Corzo said that in 2013, the Conference Board Working Group on Alternative Pay Disclosure issued a white paper regarding “realized pay” and “realizable pay.” The working group members included those from the Center on Executive Compensation, which has public company executives on its advisory board, the Society of Corporate Secretaries & Governance Professionals, and securities lawyers.

Corzo said applying the different approaches to Oracle Corp. illustrates how the formulas can understate executive compensation levels compared with the summary compensation table total amounts required by Item 402.

Over the past three years, Oracle CEO Larry Ellison received $253.3 million according to the summary table. Using the Conference Board’s “realized pay” formula, the total was $200.4 million, Corzo said. The “realizable pay” calculation showed a total of $140.7 million.

The CII’s Mahoney said the SEC should write rules so that investors can better understand the relationship between all pay and performance.

“Regardless of whether a given component of pay is deemed directly related, indirectly related, or unrelated to performance, investors want to know the connection between the capital they provide and the performance delivered in return,” Mahoney wrote. “Thus, we believe it would be inappropriate to exclude from the pay-for-performance disclosure compensation such as executive compensation payments of one-time bonuses for new hires, ‘make whole’ awards for forfeited pay, and any other compensation that is clearly actually paid.”

The CII also urged the SEC not to exclude any form of compensation that is considered not “actually paid.”

“Some companies will attempt to game the disclosure by decreasing executive compensation that the commission determines to be actually paid and increasing executive compensation for those forms of compensation that are excluded from the commission’s determination,” Mahoney wrote.

The AFL-CIO said the SEC should consider requiring disclosure of quantifiable pay-for-performance measurements, numerical formulas, and payout schedules.

“Such metrics are routinely used to set executive pay formulas, but they are rarely disclosed on a forward-looking basis,” Corzo wrote. “Requiring all companies to disclose this information will neutralize any competitive disadvantage resulting from the disclosure of proprietary information.”