Speech by SEC Staff:
Opening Remarks Before the 15th Annual NASPP Conference
Linda Chatman Thomsen1
Director, Division of Enforcement
U.S. Securities and Exchange Commission
San Francisco, California
October 10, 2007
Thank you Jesse and congratulations on your fifteenth birthday. It is a great pleasure to be here in San Francisco today and in particular to be participating in such an important, informative event. I can't think of a time when executive compensation and the rules and regulations governing it were more important or more in the public eye.
Let's start with some basics. As has been mentioned, I am the Director of the Division of Enforcement. Most of you don't ever want to see me. But experience suggests that some of you will. Indeed I suspect some of you have. While we in Enforcement love our jobs, rumor has it that those we investigate aren't exactly thrilled about the experience. So I thought I'd spend some time today talking about ways to reduce the possibility of finding yourself in the midst of an enforcement investigation.
Before I go any further I should remind you that my views are my own and do not necessarily reflect the views of the Commission or any other member of the staff. I also should remind you that my home at the Commission is in the Division of Enforcement not the Division of Corporation Finance. As such, my views are uniquely colored by what I see, which is, to put it bluntly, often not pretty. To use two well-worn expressions: my glasses are not rose colored and in Enforcement, we're more about sticks and not so much about carrots.
Because, as the saying goes, those who don't know history are destined (some would say doomed) to repeat it, let's start with a little history of enforcement and compensation disclosure.
It was not so long ago that the Commission charged General Electric for its failure to disclose the benefits that its most famous CEO and Chairman would receive in retirement.2 General Electric did disclose that its former top executive received certain "facilities and services." However, the Commission found that the company violated the proxy solicitation and periodic reporting provisions of the Exchange Act by failing to fully and accurately disclose what those facilities and services actually entailed: among other things, lifetime, unlimited personal access to GE aircraft and exclusive use of a furnished New York City apartment with a rental value of some $50,000 a month. Similarly, in its proceeding against Tyson Foods, the Commission found that Tyson's disclosure that its departing chief executive would receive "travel and entertainment costs consistent with past practices" was inadequate to describe the actual multi-million dollar benefits being granted.3 The story was no better at Tyco, where the Commission found the company failed to adequately disclose numerous and extensive perquisites of three former top executives, who enjoyed living rent-free; millions of dollars in loan forgiveness; and company gifts of yachts and jewelry.4
On another compensation-related front we have the recent option backdating cases. To date, the Commission has brought enforcement actions related to options backdating against more than 25 former executives associated with more than a dozen issuers. Executives charged include former CEOs, General Counsels, CFOs and one former Compensation Committee Member. These cases have involved secret slush funds; forgery; grants to fictitious employees, former employees and unknown future employees; falsified corporate documents; cancellation of legitimate grants that had fallen out of the money and substitution of illegally backdated grants that were already in the money; self-dealing; self-enrichment; attempted cover-ups; and lying to the auditors. And notably, the conduct of several inside lawyers in these scandals should make us all pause. The Commission has sued seven former General Counsels of eight publicly traded companies for stock options abuses.5 Sadly, in each of these cases we alleged that to further the respective scheme, the company's inside counsel altered or fabricated company records to advance or conceal the fraud.
For a moment I'd like to touch on a topic that is the subject of the next panel discussion and which has not been the subject of any enforcement actions to date: 10b5-1 plans. First authorized in 2000, 10b5-1 plans allow corporate executives to make a plan, at a time when they are not in possession of inside information, to make prearranged trades at specified prices or dates in the future.6 The idea was to give executives opportunities to diversify or become more liquid through the use of plans with prearranged trades without facing the prospect of an insider trading investigation. Since these plans were authorized, more than 35% of all S&P companies have had at least one executive sell shares under a 10b5-1 plan.7 In 2006 alone, executives sold more than $8.5 billion in stock through 10b5-1 plans.8
Recent academic studies suggest that Rule 10b5-1 may be being abused. The academic data shows that executives who trade within a 10b5-1 plan outperform their peers who trade outside of such a plan by nearly 6%.9 Presumptively, plan participants should be no more successful on average than those who trade outside a plan. There may be perfectly legitimate reasons for the discrepancy. The date suggests that executives with plans sell more frequently and more strategically ahead of announcements of bad news. This raises the possibility that plans are being abused essentially to facilitate trading on inside information. So we're looking. We want to make sure that people are not doing here what they were doing with stock options. If executives are in fact trading on inside information and using a plan for cover, the plan will provide no defense. We and others are looking at the disclosures surrounding 10b5-1 plans. We're looking at multiple and seemingly overlapping 10b5-1 plans and at asymmetrical disclosure around plans — that is, disclosure of entry into a 10b5-1 plan, without timely disclosure of related plan modifications or terminations.
Returning to those historical cases, let's ask ourselves what went wrong. All are examples of situations where rules and laws were broken in both letter and spirit. Now, while that is true I expect it is not especially helpful. Many of you assume that you could never find yourself in such a jam and that those who did were either a dumb or thoroughly corrupt cluck. While that is undoubtedly true in some situations, in the spirit of the new disclosure rules, let's look and think a little deeper. Much has been said today and yesterday about the principles underlying the new rules. It is worth remembering that those same principles animated the old rules just as they animate most of the securities rules and regulations. Those principles include: make full and fair disclosure and speak candidly and clearly. We at the Commission have long said that we are not in the business of telling business what to do, but rather insisting that whatever business is doing is disclosed. Perhaps somehow that got distorted into the notion that anything goes. Of course that's not the case. Underlying the notion of full and fair disclosure is the expectation that if you have to spell it out clearly, you may decide not to do it. Indeed that is precisely what Justice Brandeis had in mind when he talked about sunlight being the best disinfectant. Unfortunately, in some instances this got distorted — people started from the anything goes premise and, when confronted with the fact that it was difficult to justify a candid recitation of a practice, opted to obfuscate rather than think about changing the practice.
Now of course that's all history and part of me is an optimist — in Enforcement we'd like to be like the Maytag repairman and put ourselves out of business. So what can you do to help us accomplish that?
Among other things, there's always listening. A few things are worth repeating and hearing twice. In 2004 then-director of the division of Corporation Finance Alan Beller said "all means all" — all means all.10 Yesterday, John White, the current director of corporation finance, said pay attention to analysis and pay attention to presentation: pay attention to analysis and pay attention to presentation.11 And most of all, last year John White said "principles matter" — principles matter — and you didn't need John White to tell you so.12 Yesterday, he said principles still matter — principles still matter13 — and I hope that wasn't news. And on this point, I hope there is no doubt, principles always matter.
As the Commission has said, the compensation rules are principles-based. Okay, so what does that mean? The Commission essentially has said that investors are entitled to a clear picture of all executive compensation, as well as the policies and reasons behind the numbers. Notably and contrary to some commentators, "principles-based" does not mean discretionary. And I can tell you from my perspective, it certainly does not mean that the Commission won't aggressively enforce compliance with the new disclosure requirements.
But that's not to say that disclosure has become more complicated or that there aren't very specific rules that you must comply with. Of course there are specific rules you must follow and just yesterday Corporation Finance released a report containing some very useful guidance on those rules vis a vis what they have seen from a select group of some 300+ filers since the new rules have been in effect.14
I will leave comprehensive guidance on the new rules to my very capable colleagues in Corporation Finance; however, I do want to mention a couple of quick things to consider. Over-reliance on vague or misused terminology or jargon can mislead investors. There has been a lot of discussion about the readability and length of compensation disclosures — the so-called plain English requirements. I'd like to reiterate a point that has been made often. The use of descriptive headings and subheadings can help readers navigate and digest material. I mention this because we in Enforcement have found headings and subheading quite effective in those enforcement actions I'm sure you want to avoid.
Let's spend a minute or so on semantics. Difficult is not a synonym for complicated. And simple is not a synonym for easy. What do I mean? I know I'm not telling you anything you don't already know but in some quarters there is a cloud of suspicion hanging over your executive compensation disclosures. In some circles, you are up against a presumption that you are trying to rationalize the unjustifiable. According to an Associated Press survey of nearly eighty percent of the Fortune 500 companies, CEOs of large U.S. companies last year averaged $10.8 million in total compensation.15 That is more than 364 times the pay of the average U.S. worker.16 Indeed, workers on the bottom rung of the economy have just received their first federal minimum wage increase in a decade.17 Attention to these pay discrepancies recently led the House of Representatives to pass The Shareholder Vote on Executive Compensation Act, more colloquially known as the "say on pay" bill.18 The bill — which currently is awaiting action in the Senate — seeks to give shareholders nonbinding advisory votes on executive compensation policies at their companies, as well as an additional nonbinding advisory vote on golden parachutes being negotiated when their companies are in the midst of mergers and acquisitions.19 This environment may justifiably be described as difficult but it doesn't mean that the disclosure of what you're doing is complicated — it just may be hard to sell. But that does not justify deviating from the mandate to speak candidly and clearly.
On the simple is not always easy point, I am reminded of a quote generally, although not always, attributed to the Great American author Mark Twain. He once noted in a lengthy letter to a friend that he "would like to have written a shorter letter but didn't have the time."
In closing, I'd like to return to principles by way of historical example — Benjamin Franklin. He is a quintessential American success story. He was born in Massachusetts, the 15th child of a Boston candle maker. Not only was he a writer, scientist, inventor and statesman, he was a great entrepreneur.20 Over the course of his life he amassed a fortune. He had brains, ambition, a limitless capacity for work — he had, in short, everything a new country needed and everything we still value. Were he alive today, Franklin would undoubtedly be one of our most highly compensated CEOs.
Franklin, as the saying goes, printed money. But in his case that was literally true; his print shop was entrusted with printing money. Perhaps his reputation had something to do with that; that might also explain why he was also one of America's first ethicists. At some point he articulated a list of thirteen virtues to which his descendants should aspire: Temperance, Silence, Order, Resolution, Frugality, Industry, Sincerity, Justice, Moderation, Cleanliness, Tranquility, Chastity and Humility. Franklin explained that he added Humility to the list when an honest friend informed him that he "was generally thought proud; [his] pride showed itself frequently in conversation; [and he] was not content with being in the right when discussing any point, but was overbearing, and rather insolent." Franklin was also candid about his own attempts to conquer his pride. "In reality, there is, perhaps, no one of our natural passions so hard to subdue as pride. Disguise it, struggle with it, beat it down, stifle it, mortify it as much as one pleases, it is still alive, and will every now and then peep out and show itself … even if I could conceive that I have completely overcome it, I should probably be proud of my humility." 21
So again you may ask, what is my point? As Franklin points out, it is important to focus on the important things. And, as his candor suggests, that's not always easy. But as his example makes clear, and as we already know: principles matter; principles still matter; and principles will always matter.