Wag of the Finger/Flip of the Bird

Stephen Colbert has a recurring segment called "Tip of the hat/Wag of the finger," where he alternately praises and condemns something or other. I thought I should have something similar, but since I rarely have anything nice to say, I've decided to call it "Wag of the Finger/Flip of the Bird."

Yes, I know both involve wagging fingers. That's not the point. It's the intensity that counts.

Unfortunately, my first wag of the finger goes to me. During the holidays, I predicted that incoming House Financial Services Committee Chairman Barney Frank would hold hearings on CEO pay (which is admittedly a no-brainer, since he had already said as much), but also that several professors would testify that high CEO pay results from a combination of a "Lake Woebegon effect" plus poor corporate governance standards. I also said all of this will be ignored and Congress will instead focus on some kind of CEO windfall tax. Then, on Dec. 27, Barney Frank let loose a broadside at the SEC regarding its year-end rule change regarding CEO compensation disclosure (see here). I noted that the SEC's decision to allow companies to disclose executive stock option awards over time, as they are exercised, made sense since that method of disclosure paralleled FAS 123R, the relevant accounting standard. However, I also said that Frank had a point, in that what many shareholders really want to know is when the board grants executive stock options (and how much), rather than how much they are costing the company each year as they become due.

Well, that was wrong. As Kevin Drawbaugh of Reuters reports (US SEC's Cox: no options hiding in exec pay rule), the new SEC rule does indeed change how public companies need to report the costs of stock options (i.e., as they options are exercised), but they still have to report option grants as they are issued, and in their entirety -- just in a different section on executive pay. I probably could have figured that out if I had actually read the SEC rule release all the way through, and parsed its extraordinarily boring language, and cross-referenced it with other SEC rules. But I didn't. Because it was boring. And I have a real job. (BTW, one of my homies was asking how I have time to do this and my real work. It's because I make these things up. If I had to actually get my facts down airtight, it would take me a long time and this wouldn't be nearly as much fun.)

So, wag of the finger to me. But while I'm at it, wag of the finger to the SEC, for writing such a deathly boring rule release and not accompanying it with a press release that highlighted, bolded, italicized, and included an XBRL-encoded .wav attachment that screamed at you that this new rule means companies now have to disclose all the information they used to, plus more!

More importantly, though, a Flip of the Bird goes out to Congressman Barney Frank. First, for making me wag my finger at myself. It's terribly bad ergonomics. But the Flip also goes for going off half-cocked like that. Don't you have anyone on your staff able and willing to read through these boring SEC rule releases? Maybe make a few phone calls on the ones they don't understand? I know House members get stuck with the dregs of Congressional staffers, but you would think with a new chairmanship you could at least hire someone who could make a few phone calls. But, no, instead Frank issues this press release and gets me (and apparently some shareholder activists) all confused. Since the Commission voted five to zero on this (and that includes two Democrats), you might want to see what's going on before getting all "very disappointed."

Or was it that you were offended that the SEC would do something like this without consulting you first? Hey, I know you've been itching a long time to get a position in Congress where you are actually relevant, but you shouldn't need that much hand-holding. Ok, ok, you're relevant and important! Now, with that little bit of affirmation out of the way, step back and get your facts straight before your next tirade. Because otherwise I'm going to have to go read all this crap, and I just don't have the time.

My 2007 Predictions: Does this count?

Not really, I guess. On Dec. 27, just a few hours before I made my New Year's predictions (here), incoming House Financial Services Committee chairman Barney Frank issued this press release criticizing the SEC's December 22 decision to align its executive compensation disclosure rules with existing accounting rules. This new rule, which you can read here (if you a real masochist), replaces the existing SEC rule that says that when companies give executives stock options, these options have to be disclosed at the time of the grant. The new rule follows Financial Accounting Standard 123R (which you can read here, if you are really really really masochistic), so that public companies now only have to disclose the grant as they are exercised (i.e., when the executive actually calls in the grant and the company has to fork over the money to buy the shares).

There is some logic to this new rule, since a grant of stock options is worthless until it is exercised, and they can be exercised at different times. In other words, under the old approach, a company could disclose that it issued a CEO 1000 stock options in one year (not necessarily indicating the price of the stock), and nothing over the next five years, with an annual salary being (for example) $500,000. The disclosure would then look like $500K +1000 stock options in Year 1, then $500K for Years 2 through 6. Under the new rule, the company would have to disclose the stock options, and the fair market value, when the options become exercisable. In other words, if 100 of the 1000 options become exercisable each year, in Year 1, the company would disclose $500K in salary, in Year 2 $500K + 100 stock options at $1000 per share, in Year 3 $500K +100 stock options at $1100 per share, etc. The idea is to give investors an idea about how much the CEO is costing the company each year, and how much the CEO is actually making in each year. Furthermore, this is how companies currently have to account for stock options. (In the past, issuers did not have to expense stock options at all.)

Despite the logic behind the SEC's decision, you could argue that it comes at a bad time. Executive stock options are in the news because of the backdating scandal. Most people don't understand what the issue is about, except that it's bad. Add on top of that the view of some that what investors really want to know about is when the board decides to grant stock options (not necessarily when the come due or when the CEO exercises those options), and it could look like the SEC is making it harder for investors to know how overpaid the CEOs of their companies are. And that, of course, is what Barney Frank is saying.

I am very disappointed with both the substance and the procedure used to reach the SEC’s Christmas Eve decision to loosen reporting requirements for the pay of the top executives of public corporations. It is especially ironic that the SEC would relax the rules regarding stock options at precisely the time that widespread abuses of the practice are coming to light. The problem of executive pay that is both greatly excessive and deliberately obscured is a grave one. I had been encouraged when the SEC recognized this problem in its initial proposal, and while that continues to provide improvements in the relevant rules, this slippage is regrettable both substantively and for not having been open to more public discussion. 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 that is now unconstrained by anything except the self restraint of top executives, a commodity that is apparently in insufficient supply.

Frank also indicated that he will seek legislation to allow shareholders to vote on executive compensation. If this legislation succeeds, it will be the second direct foray of the federal government into corporate governance issues, an area of U.S. law that traditionally has been the province of state law. (The first, of course, being the Sarbanes-Oxley Act, which set requirements for issuer board composition.)

So, I guess my prediction that Barney Frank will hold hearings on executive compensation is a no-brainer. (I guess we'll have to see about the professors and Lake Woebegon.) However, if Frank does go ahead with corporate governance legislation rather than some kind of windfall tax, I'll have been happily proven wrong.