Speech by SEC Commissioner:
Remarks Before the National Association of State Treasurers (NAST)
by
Commissioner Roel C. Campos
U.S. Securities and Exchange Commission
Washington, DC
March 6, 2006
I. Introduction
Good morning everyone, and thank you, Brian, for that kind introduction. I can't help but note how interesting and wide-ranging the agenda for this meeting is, and I'm honored to have been asked to contribute. Before I start, I must issue the standard SEC disclaimer that this speech expresses my personal views, and does not necessarily reflect those of the Commission, other Commissioners or members of the staff. With that said, let's move on to business.
I thought that I would focus today on a few related topics that are, or in my opinion, should be, on the SEC's current agenda, and which I am sure are of interest to some or all of you. These topics are executive compensation, shareholder access and internet availability of proxy materials. As you may know, the Commission has issued proposed rules on all of these subjects. I believe the comment period on the internet proxy rule expired in February — and the comment period on shareholder access has long since expired — but you still have until April 10th to submit comments on the executive compensation proposal, if you so desire. Given your collective expertise as state financial leaders, I would personally welcome any comments that you might have on our proposal.
Of course, if there is time for questions perhaps we can also discuss items such as our hedge fund registration rules, internal controls under Section 404 of Sarbanes-Oxley, or other topics that you may be interested in.
II. Executive Compensation
Otto von Bismarck is once reported to have stated that "Laws are like sausages. It's better not to see them being made." The implication of this quote is that the law-making and sausage-making processes may not be as attractive as the end result and are perhaps not something that anyone would want to witness. But at least with sausages and laws, the end result is generally viewed as somewhat attractive (with some obvious exceptions). By contrast, however, when it comes to executive compensation, not only is the process often incomprehensible, but in many cases so are the end results.
It is fair to say that many of the decisions surrounding executive pay in the public companies in the United States have been made in very dark corners, difficult to discern and understand fully. Retirement benefits that have included New York City apartments and free use of corporate jets are one example. The automatic pay to certain executives upon the completion of a merger astounded many investors.
Well, last month, the Commission did something about this and issued a comprehensive set of proposals, which set forth a new disclosure regime for the compensation of the five top executive officers and directors of public companies. Essentially, this requirement will provide a "one stop shopping," in the proxy statement where investors and the public can discover all of the aspects of executive compensation. Through a set of very clever tables and narratives, the proposed rules will require that the various elements of executive compensation be revealed: cash, incentive pay, equity (including all manner of options and restricted stock), retirement benefits, and change in control compensation. The new rules will require that the options be priced, presumably using the method (Black Scholes or others) that is used in expensing the options. Most importantly, these tables provide for the computation of a total amount of compensation in the summary table of the executive's compensation. Imagine that — one figure that puts all of these compensation elements together. Of course, there will be some elements such as retirement that will principally be in narrative form, but the rules will require that examples be given as to what the executive will earn if normal conditions occur.
The levels of executive compensation in the U.S., and the disparity in pay between executives and regular employees, also argue in favor of improved disclosure. In 1982, the ratio between chief executives and the average employee was 42:1. In 2004, the ratio of the average CEO pay to that of the average non-management worker in the U.S. was 431:1. Ultimately, how much executives earn is a decision to be made by shareholders through the board of directors. The SEC will never tell companies how much they should pay executives. Rather, our concern is that full and complete disclosure of compensation be made to shareholders.
In the past, I have often heard from investors that it is difficult to figure out from the current filings and disclosure what executives really earn. In particular, sometimes it can be extremely difficult to dig through all of a company's disclosures to discover what type of deferred compensation, change in control payments, retirement arrangements, or other perqs have been negotiated. Moreover, it is troublesome that such pay arrangements in many cases may not have been known to shareholders, and in some cases, even understood by directors. Often, high pay seems to be totally unrelated to performance, which is something that almost always rubs shareholders the wrong way, particularly when they aren't fully informed until after the fact.
It is my hope that our proposals provide investors a tool that will enable them to understand the total compensation paid to the company's CEO, CFO and other executive officers, and consequently to assess whether those executives, through compensation arrangements approved by overly complacent directors, are essentially raiding the company's till. While it is difficult for shareholders to formally oust directors who shareholders believe might not be capable of running their company — a topic that I'll return to in a moment — I still believe that public pressure, withhold vote campaigns, and behind the scene discussions with management can be used by investors to bring about change in compensation.
There are certain issues that have been pointed out regarding our executive compensation proposals. For example, the proposal does not require the disclosure of specific quantitative or qualitative performance-related factors considered by the compensation committee or by the board in determining executive compensation. The stated reason for not including such a requirement would be to avoid forcing companies to disclose confidential commercial or business information that would have an adverse effect on the company. This is certainly understandable. On the other hand, without disclosure of these performance-related factors, it becomes difficult for shareholders to determine whether the targets are appropriate and whether executives have actually met the targets. Perhaps a middle alternative would be to require disclosure after the fact: that is, would it be effective and appropriate to require companies to disclose the particular quantitative or qualitative performance-related factors after the time period for which the factors apply? Would this make the executive compensation process more transparent, yet alleviate concerns about disclosure of confidential information? Or would disclosure of specific targets even after the fact still raise confidentiality issues that might ultimately harm the company? This is something that we at the Commission should consider, and I intend to fully study the issue and approach it with an open mind.
A second issue that companies seem to be concerned about is the requirement that companies disclose, in addition to the pay of the top five executive officers, the pay of the three other highest earning employees. This will mean, for example, that the top salesperson's compensation might be disclosed in certain cases. Some companies think that this is disclosing a business confidence. However, the employee's identity can be kept confidential, and I am not sure that any true business confidences are affected. I will keep an open mind, though, and listen carefully to those who have concerns.
At this point it is the public's turn to comment on our proposal — to tell us what you like and don't like. As state treasurers, each of you has a great responsibility. I'm sure that you've all thought a great deal about corporate governance generally and executive compensation in particular. I urge you to read our proposal and to tell us what you think about it. I know that your thoughts and ideas would be most appreciated.
III. Shareholder Access
Let me now turn to the related issue of shareholder access. I'd like to talk briefly about two rules the Commission has proposed. First, I want to refresh your recollection about a rule that we proposed almost two-and-a-half years ago regarding shareholder director nominations, and then I'll also mention a much newer proposed rule regarding internet proxies.
I'm sure that the thought crossed at least some of your minds that I was being overly optimistic earlier about the ability of shareholders to have a meaningful chance to affect executive compensation, even if our executive compensation proposal is adopted. In fact, I made a similar comment in my remarks at the SEC meeting in which the rule was proposed, and I note that at least one commenter has written in and specifically criticized me on this point. Perhaps it is a fair comment, given the current state of shareholder access to the director nomination process.
In particular, I'm referring to the fact that unless a shareholder mounts a full-blown proxy fight — which is very expensive and time consuming — shareholders do not even have a real option of voting for a director other than one supported by management. Further, in the United States, unlike the UK and other jurisdictions around the world, shareholders in most public companies use a plurality voting system, which essentially means that those directors receiving the most votes are elected to the board, even if those directors do not receive a majority of the votes cast. The only choices are to "vote for" a director or to "withhold" one's vote for a director, and a director will still be elected even if the votes "withheld" exceed the votes "for" a director candidate. Consequently, as a result of the difficulty of nominating alternative candidates for director, coupled with plurality voting, it is — as many have noted — very difficult to remove or replace any of the directors appearing on management's slate.
And that is why I am still supportive of the proposals that we introduced in late 2003 which would have, under certain circumstances, required companies to include in their proxy materials shareholder nominees for election as director. Had they been adopted, these rules would have created a mechanism for nominees of long-term shareholders with significant holdings to be included in company proxy materials where there are indications that shareholders need such access to further an effective proxy process. Obviously, our proposal was somewhat controversial and the rules have not been finalized, but I still believe that this is a subject that the Commission must address in the future.
IV. Internet Proxy
The Commission has, however, more recently proposed additional rules that impact shareholder access, although perhaps not quite so directly as our 2003 proposals. In particular, I'm referring to the amendments we proposed late last year to the proxy rules that would provide an alternative method for issuers and other persons to furnish proxy materials to shareholders by posting them on an Internet Web site and providing shareholders with notice of the availability of the proxy materials. Under the amendments, shareholders could choose to affirmatively "opt out" of the Internet delivery regime and receive paper copies of the materials at no cost, but the default rule would be one of "notice and access." The proposed amendments are intended to put into place processes that would provide shareholders with notice of, and access to, proxy materials while taking advantage of technological developments and the growth of the Internet and electronic communications. Issuers that rely on the proposed amendments may be able to lower costs of proxy solicitations that ultimately are borne by shareholders. The proposed amendments also would apply to a soliciting person other than the issuer, which also has the potential to reduce the costs of engaging in a proxy contest.
When the Commission voted to propose these amendments, I commented at our open meeting that I supported the proposals because I liked the idea of reducing the cost of soliciting proxies. However, I also cautioned that we should take great care in ensuring that the proposed rules, if finalized, would not have unintended consequences.
A. Separating the Proxy Card from the Proxy Materials
In particular, I was — and I remain — concerned about an aspect of the proposal that would allow companies to separate the proxy card from the rest of the proxy materials. As currently proposed, the rules would allow a company to include a proxy card with the mailed notice of availability of proxy materials, but would permit the company to post the proxy statement and annual report on its website. My concern about this arrangement — that is, the separation of the proxy card from the rest of the proxy materials — is that it might encourage shareholders to vote their proxies without reading the information in the proxy materials. If this occurs, I think we run the risk of undermining the spirit of the proxy rules.
At our open meeting, I specifically noted that our proposal solicits comment on this point, and that we would have to carefully consider the comments that we receive. Not surprisingly, we have received many comments on the proposal, and more than a few commenters have shared my concern about separating the proxy ballot from the rest of the proxy materials. Moreover, at least two comment letters have pointed to separate shareholder surveys indicating that shareholders would, in fact, be less likely to look at annual reports and proxy materials under our proposals. Given these comments, I remain very concerned about this aspect of our proposals, and I'm committed to finding a solution to this.
One option may be to prohibit companies from sending the proxy card with the notice, and instead to require the proxy card to be available only electronically with the rest of the proxy materials. In such a case, the shareholder could either print out the card and mail it in, or alternatively, simply vote electronically. I know that some have criticized each of these options: first, having shareholders print out the proxy adds a second step to the voting process; and second, there may be technological obstacles to overcome in administering electronic voting.
But I'm also confident that each of these issues can be addressed. As for the first criticism, well, under the rules as currently proposed, there is already a two-step process: first, investors receive the notice and proxy card; and second, investors go to the Internet to view the proxy materials.
As for the second criticism, my answer is that there already is widespread electronic voting in practice today. This system will likely have to be tweaked to accommodate our proposals. But so far, it hasn't been explained to me why it would be technologically difficult to direct shareholders to a website containing the proxy statement via the mailed notice, and then have those shareholders click on another link to a website containing the proxy card.
In any event, the staff is studying the comment letters now, and we'll see if we can reach consensus on this issue.
B. Opting Out of Electronic Delivery
Another area of concern that I have about our internet proxy proposal stems the fact that our proposal essentially changes the "default" rule to one of electronic delivery, with shareholders being required to affirmatively opt for paper delivery for each company and during each proxy season. By contrast, the current "default" rule is one of paper delivery, although shareholder may affirmatively opt for electronic delivery. We have received a number of comment letters expressing apprehension about changing the default rule, including a number of surveys indicating that requiring shareholders to "opt out" of electronic delivery may disproportionably impact certain groups of investors, such as seniors.
This is something that I think should be addressed. Some of the commenters have requested that we modify the rule by requiring shareholders to affirmatively "opt in" if they want to receive the proxy materials via the Internet. Others have suggested retaining the "opt out" feature of the proposed rule, but have recommended that once a shareholder chooses to "opt out" of Internet delivery, the "opt out" should be permanent; that is, it should stay in effect until the shareholder changes its mind, rather than automatically defaulting back to Internet delivery each year. I think both of these suggestions are interesting, and again, require further thought by the Commission and our staff.
V. Conclusion
Well, I think I've used up most if not all of my time here. In summary, I'd just like to say that your views are important. I hope you feel free to contact me about any issue that you feel strongly about that is under our jurisdiction. Thank you for your kind attention, and I think we have some time for questions.
http://www.sec.gov/news/speech/spch030606rcc.htm
