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From Securities Regulation Daily, April 29, 2015

SEC proposes pay-versus-performance rules, moves ahead on security-based swaps

By Mark S. Nelson, J.D.

The Commission today voted 3-2 to propose rules that would implement the Dodd-Frank Act’s pay-versus-performance provision. That proposal drew sharp critiques by Commissioners Daniel M. Gallagher and Michael S. Piwowar, both of whom said it lacks flexibility. But the Commission unanimously proposed to move ahead with its implementation of the Dodd-Frank Act’s security-based swaps provisions, this time dealing with a key aspect of cross-border swaps enforcement. Comments on both proposals are due 60 days after they are published in the Federal Register.

Pay-versus-performance. The pay-versus-performance proposal would implement provisions in Dodd-Frank Act Sec. 953(a). According to a fact sheet issued by the SEC, the new disclosure will be contained in proxy or information statements and will require a new tabular presentation showing the compensation actually paid to a company’s principal executive officer (i.e., the amount in the summary compensation table with some adjustments). For other named executive officers, a company would disclose the average compensation actually paid to them.

The new disclosure must include information about a company’s total shareholder return. This data can be presented according to the existing requirements for stock performance graphs contained in Item 201(e) of Regulation S-K. The proposal has an exception for foreign private issuers, registered investment companies, and emerging growth companies.

Larger reporting companies must include data on pay-versus-performance for the last five fiscal years, while smaller reporting companies need only include data for the past three years. But a phase-in applies for both large and small companies regarding the number of years covered. Smaller reporting companies also need not present a peer group TSR (total shareholder return).

Chair Mary Jo White said the commissioners reviewed pre-comments submitted on this part of the Dodd-Frank Act and that the proposal retained flexibility to let a company address its specific situation. She also said she wants to hear from commenters on a range of topics, including how the pay-versus-performance information will be used, whether shareholders will use the information, and how smaller companies will use this data and bear the costs of its collection.

Commissioner Kara M. Stein noted that the first tabular executive compensation disclosures began in 1943 and that this type of information has remained of interest to shareholders. She cited the Senate report on the Dodd-Frank Act, which stated: “It has become apparent that a significant concern of shareholders is the relationship between executive pay and the company's financial performance for the benefit of shareholders. Shareholders are keenly interested when executive compensation is increasing sharply at the same time as financial performance is falling.”

Commissioner Luis A. Aguilar cited studies implying a “disconnect” between executive pay and company performance during the Great Recession. According to the commissioner, the proposed rules leave the choice of how to compensate top executives to companies’ boards. He said the rules instead focus on disclosures about the linkages between pay and company performance.

But Gallagher and Piwowar each expressed worries about the details of the rules that prevented them from backing the proposal. Gallagher said he is concerned that the pay-versus-performance proposal is yet another intrusion by a government regulator on a corporate governance matter best enforced under state laws.

Gallagher also disagreed with the proposal’s prescriptive character and its reliance on the TSR. He said the stock-based TSR can be prone to emphasizing short-term corporate goals over long-term ones. Moreover, Gallagher would have preferred an approach focused on a company’s principal executive, rather than all named executive officers as proposed.

According to Piwowar, attempts to regulate executive compensation can easily backfire. He cited Internal Revenue Code Sec. 162(m) as a prime example of how federal laws and regulations can push companies to focus too much on short-term issues instead of long-term growth.  He also voiced worries about the lack of a principles-based approach to pay-versus-performance disclosures. He said he might have backed an earlier draft proposal that was more principles-based.

Moreover, pay-versus-performance disclosures must be tagged in eXtensible Business Reporting Language (XBRL) (smaller companies will have a phase-in period to meet the XBRL requirement). Keith F. Higgins, director of the SEC's Division of Corporation Finance, noted this is the first time that data in a proxy or information statement will be tagged in XBRL.

Commissioners Stein and Aguilar lauded the proposal’s use of XBRL because it can streamline the collection and reporting of executive compensation data and enable greater comparability across peer companies. Stein said she hopes the Commission will eventually require use of XBRL for the entire proxy. But Commissioner Piwowar said the proposal may not be designed to make the best use of XBRL.

The SEC has now proposed rules for four of its eight Dodd-Frank executive compensation mandates. Of these, the pay ratio disclosure proposal and the incentive-based compensation rules have inspired the most controversy, as measured by the number of comments the SEC received (128,359 so far on the pay ratio rule, and over 11,000 on the incentive-based compensation rule). The Commission still must propose rules to implement Dodd-Frank Act Sec. 954 regarding the recovery of erroneously awarded compensation.

In 2010, the Commission approved changes to NYSE’s and NASDAQ’s rules on broker voting. The Commission adopted final rules to implement the shareholder say-on-pay requirements in 2011 and, in 2012, adopted final rules to implement requirements for listing standards regarding compensation committee independence.

Security-based swaps. The Commission also unanimously proposed rules to implement some of the cross-border features of the Dodd-Frank Act’s mandate regarding security-based swaps. White emphasized that the proposed rules focus on dealing activity of non-U.S. persons in the United States. She said the SEC is aware of the CFTC’s efforts in this area and of the potential impact the Commission’s rules, if adopted, could have on the global derivatives marketplace. White also noted the significant consultations between staffers at the SEC and the CFTC.

A fact sheet explained that the proposal would require a non-U.S. person to include in its de minimis threshold calculations any transaction connected with its dealing activity that it arranges, negotiates, or executes using its agent’s personnel located in the United States. Exchange Act Sec. 15F(h)’s external business conduct requirements would apply to the U.S. business of a registered security-based swap dealer. Moreover, the proposal would bring security-based swaps within Regulation SBSR’s reporting and public dissemination requirements, if certain conditions are met.

Stephen Luparello, director of the SEC's Division of Trading and Markets, emphasized the need for a common test for swaps and security-based swaps that is focused on the activity-based aspects of dealers’ market-facing activities. He said the SEC is concerned with U.S.-specific effects of security-based swaps markets, and that most risk is located outside the United States. Division of Economic and Risk Analysis Director Mark Flannery said the proposed rules would minimize the risk that swaps trading will go overseas without any U.S. regulatory oversight.

Aguilar urged the Commission to quickly finish its swaps rules because the SEC now lags the CFTC in this area. While Gallagher said he still has some reservations about the SEC’s swaps rules, mostly stemming from the Dodd-Frank Act being “needlessly complex,” he nevertheless backed the proposal in order to get comments on the impact the draft rules may have on U.S. competitiveness in global capital markets. Piwowar noted that the swaps proposal was a “key step” for the SEC. Aguilar backed the proposal, as did Stein, who noted the draft rules are “specifically tailored” for security-based swaps markets.

MainStory: TopStory CorporateGovernance Derivatives DoddFrankAct ExecutiveCompensation RiskManagement SECNewsSpeeches Swaps

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