Subject: File No. S7-03-06
From: Timothy H. Buchman

April 10, 2006

Executive Summary:
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Both the current and the proposed compensation reporting tables may inadvertently convey misinformation. The development of various retail equity derivatives (that is, means of shifting an individual's risks without transferring ownership) make it possible for executives to diversify their investments without affecting the accuracy of information in proxy statement tables of awards and ownership. This can result in tabular data that imply ownership risk stakes that no longer fall on the named executive. The narrative text in a proxy, describing Compensation Committee efforts to align the interests of named executives with long-term shareholders may describe a futile strategy that is presented as an effective one.

Submission Comments:
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The Commission's Request For Comments(RFC) on Page 67 of the .pdf form of the Proposal asks,

"Should we require, as proposed, that options or similar awards that have been transferred by an executive must still be included in the table? Should continued disclosure depend on the nature of the transfer or the identity of the transferee?"

This request, while of value to evaluation of the proposed rules, does not cover the full range of possibly inaccurate implications to be drawn from the tables in current and proposed-rule proxy statements. This comment is limited to the accuracy of the portrayal of the named executives' securities (equities, options, and other) holdings to be disclosed in the tables.

The RFC's use of the term "transferred" is inadequate to cover the use of inventive instruments, such as derivatives, that permit the transfer of aspects of the security (particularly down and/or up-side risk) without actual transfer of the ownership of the security itself.

In general, the Commission does not seek to influence corporate decisions about compensation awards. This comment does not propose any shift in that policy. But corporations do report data (under the current regulations on executive compensation disclosure, and under the Proposal) that incorrectly describe the purported effort to align executive incentives with those of the shareholders. A typical proxy statement describes the Compensation Committee's desire to link executive pay with objectives set by the board.

"The (...company name) Long-Term Incentive Plan (LTIP) is designed to align the interests of executives with stockholders and to provide each executive with a significant incentive to manage the Company from the perspective of an owner with an equity stake in the business."

When shareholders read a table of option, common share, or restricted share awards, they assume that the recipient still owns the stated securities. To the extent that vested awards have fallen under the recipient's control, it's perfectly appropriate for them to exercise, sell, and transfer those securities, even if the table data are accurate in only a purely historical sense.

The best way to handle awards that have been transferred would be to enumerate them in a separate table. But such a table would be inadequate to provide truly accurate disclosure of the named executives' stake in the company. A variety of financial services providers openly advertise new products designed for the customer who wants to diversify concentrated holdings. These opportunities include positions that are not yet vested, so it is particularly unlikely that readers of the proposed award charts would imagine that they might have been "monetized", if not literally "sold".

Example #1:
"Yet another alternative is the variable delivery forward (VDF) -- essentially a sale of shares to the
Bank in the future, with most of the money received by the investor now. In a private transaction with the Bank, the investor agrees to sell shares to the Bank at a date anywhere from one to five years in the future. The Bank pre-funds the forward sale by paying the investor a significant amount typically 75% to 85% of the stocks current value that does not have to be repaid." ( http://www.bankofny.com/pages/data/wmi_concentrated.pdf )

Example #2:
"After the shares held in a concentrated position are donated to a CRT, they may be sold with no tax obligation. Then the full proceeds can be invested in a diversified portfolio, designed to pay income to the donor and perhaps a surviving spouse." ( http://www.cfoc-ny.org/professionals/handsondonors.shtml )

Example #3:
"Working with an experienced firm, executives will find that their choices go far beyond simply selling or holding their securities. In some cases, executives can monetize their holdings without actually selling them. The range of alternative strategies may include collateralized loans, private placements and risk management strategies, such as listed and over-the-counter options, customized hedges, prepaid forward sales, contingent foward(sic.) sales and exchange funds." ( http://www.corporateclientgroup.com/efs_wis.html )

Example #4:
"After we have evaluated your current situation, we undertake an exhaustive examination of the alternatives to help achieve your objectives, including various hedging techniques, cost-averaged selling, exchange funds, separate accounts and monetizing options." ( http://www.ustrust.com/public/file?cmsid=P-448111filename=Concentrated_Stock_Exit_Strategies.pdf )

The incomplete transparency of the current and proposed proxy statement standards is not limited to the market-listed common shares. It is apparently possible not only to monetize various positions in equity awards, but also to find derivative creators (that is, counterparties) willing to set a price on the value of assuming the risk associated with an option that is currently unvested

Some current trends towards restricted stock and away from options, alas, work in favor of such strategies. That is because the counterparty to an options monetization takes the risk that an option will be worthless by the time it vests. While it is possible that a restricted share will have zero value in the future, that probability is always lower than the corresponding probability for an option on the share.

A durable solution to these problems is not clear. Even if the Commission were to require the additional disclosure of the number of each type of security where some aspect of the award's risk no longer falls on the recipient of the award, it is likely that financial engineers seeking retail customers will find some way to evade the Commission's language. Even today, it's entirely possible that the shares an executive holds under a board-imposed ownership standard could be subject to a prepaid forward delivery. This would violate the spirit, if not the language of the Compensation Committee's rules.

It's not appropriate to discuss the issues of award vesting under change-in-control, resignation for good cause, or termination here. But because, in general, only a felony conviction (in most cases) can prevent the vesting of substantial options and equities before the future maturity of a derivative, the executive can be confident of remaining above a required ownership threshold. Without making a value judgment about current trends in the level of executive compensation, it is possible to suggest that the very volume of awards may persuade a recipient to readily accept some fraction of their likely future value, in order to reduce the risk inherent in large holdings in a single company