From: Paul Carrigan
Re: Release Numbers 33-8655; 34-53185; IC-27218
Mr. Chairman and Honorable Commissioners:
You are soliciting comments on your proposed rule "Executive Compensation and Related Party Disclosure." Your intent of the rule (amendments) as stated is to "provide investors with a clearer and more complete picture of the compensation earned by a company's principal executive officer, principal financial officer and highest paid executive officers and members of its board of directors."
The SEC has assembled an excellent rule and one of your best. It is clear, comprehensive, intelligently structured, and coherent. It is never easy to integrate the work of disparate SEC teams. One of your groups abstained from using the venerable word for these pecuniary matters - "transparency," while other groups avoided "clear and complete" with equal vigilance. The real burden to your staff was delaying this initiative far, far too long. By the time you gave them the green light, the playing field was already filled with sorely damaged and hostile stakeholders. The SEC has nothing today on the head shed remuneration mess that it didn't have ten years ago. Was this regulatory demand not foreseeable?
As you know from several previous submittals to the SEC, I am a registered professional engineer (PE) and member of the Institute of Internal Auditors (IIA). Professional engineers are engaged in the trenches of internal auditing/control to assist in the design of internal controls for financial reporting for regulatory compliance. All transactions in the sphere of accounting and auditing are governed, of course, by the same natural laws of dynamics and systems that apply to industrial processes – and everything else. All regulation and compliance schemes are engineered systems based on mathematical physics and Boolean algebra.
As an internal auditor bound by the conditions of my PE license, I get to work in the institutional boiler room at the crossroads where business as usual meets the supreme commander of my profession - natural law. The institutional advantage of PE services is to flag those schemes of regulatory compliance that are attempting to defy incontrovertible engineering principles. To illustrate, your amendments here are so late in emerging you have collided head-first with the law of optimality. This natural law states that if you have operated sub- optimum to date, nothing you can do in the future – no matter what you spend - can make up for what was lost. Don't try.
Several decades of experience has shown that investment in defiance of nature's laws is a rather common institutional condition, amounting to an obscene waste of resources. Working in the trenches also provides direct and immediate knowledge of institutional response to regulatory initiatives. In short, I work at the grunt end of the long chain of command from SEC rule making to the front lines of institutional compliance. If your rules don't engender your intended impact here in the boiler room, nothing else you do matters. While it usually takes years for the SEC to measure the impact of their rules through established channels, the places where I work get the answer in hours. If the SEC ever asked us for feedback on the outcome of your amendments, you could have the results in real time. But, alas, the request never comes.
Unlike my unlicensed comrades in internal auditing, I am duty bound as a PE to flag those projects destined to fail, invariably because of pointless natural law defiance, and carry that alert "up the ladder." If the warnings go unheeded, I am then obliged by law to withdraw from the engagement. Unlike the SOX initiatives that took weeks to translate into checklists, the response to this rulemaking on remuneration was determined and settled before it was published in the Federal Register. What the rule has done is to provide a road map to the compensation consultants for maintaining the status quo, whatever occurs. It is a windfall for the consulting industry.
The PE duty compels commentary to the proposed SEC amendments. PEs cannot be associated with a project at the time its failure is manifest to stakeholders. Such outcomes are to be foreseen contemporaneously and the required response taken. My task assignment in this commentary is to alert the SEC regarding the failure of the subject rulemaking to achieve your stated goals - foremost as parens patriae.
To honor your duty under parens patriae, an obligation shared by the PE by law, you cannot continue wholesale to deal with effects in lieu of causes, symptoms in place of diseases. As in the issue here of asynchronous head shed remuneration - the central goal of the hierarchy - engineering principles apply. In order to solve any problem manifest on level B, it must first be placed in the higher-level A context from whence it originates. The problem can only be solved on level A and the solution validated on level B. There is no alternative to this principle. It is deaf to persuasion.
It must be troubling, with all the Enron-driven rules and amendments settled in place, that the flow of corporate scandal and fraud continues unabated and parlous, on your watch, to damage your stakeholders. Here in the trenches, business as usual survived the SOX tsunami without a burp. Unlike the S&L fiasco that ran its course and left years of quiet times in its wake so the taxpayers could gradually return the money lost by the banks, there is no longer enough time to consolidate rules and rest. Ordinarily, it would be another decade or more before Congress inquired as to the effectiveness of SOX to meet the Congressional intent. With the incessant flow of corporate corruption and serious stakeholder damage featured in the media, the impact of SEC rulemaking is now constantly called into question by stakeholder/citizens. Could it be that rule-based operations is losing its commanding grip on the operational reality?
Why did the head shed think it was necessary to opacify their compensation to such an extent a cottage industry formed to render the services for remuneration increase justification, tax avoidance and stakeholder opacity? Is this what business as usual has come to? Working in internal audit through many turnovers in management, we always wondered why senior executives felt compelled to go to so much trouble to conceal their true and full compensation package. First off, they're going to collect it anyways – risk free. Second, considering the high office and authority conveyed to the head shed by the stakeholders, deliberate compensation opacity is hardly the stuff of fiduciary trust.
When you tinker with rules for executive compensation transparency, as you well know, you are messing around with the fundamental identity of an institution. The driving force for the head shed pay explosion is directly proportional to the growth in institutional insecurity. Here in their machinery room, we have noticed that the more the hierarchy perceives erosion of its power, the more frantic it becomes in raiding the corporate treasury.
Transparency of head shed remuneration will not be the end of this story. After the stakeholders find out just how gross the mismatch has become, thanks to your revelations, they will impale on the fact they are powerless to make a difference. Stakeholders will find that the SEC has provided many safeguards for management to conduct business as usual with impunity. It is most curious that you would fan the flames of stakeholder discontent when you stand fully prepared to prevent remedial action. Is this train wreck not foreseeable?
We will not ask you to do what, institutionally, you cannot. As an institution, the SEC has no alternative to engaging business as usual to regulate business as usual. The duty here ends at alerting the SEC that the subject initiative is engendering the very consequences you seek to avoid. Do as you must. There is another level of explanation and description of the drivers of this condition. A sample from that level follows.
Transparency in institutional operations
Transparency is central, hard-core engineering. For various reasons, technical and social, transparency is the design engineer's benchmark and his prize. The way transparency is misconstrued by other disciplines testifies to the wisdom of natural law supremacy in engineering affairs. Transparency is an absolute quantity that can be measured and validated with a zero-subjectivity final.
Transparency is about the fidelity of transmission. It is about transmitting something through something else. Transmission of information is governed by the laws of communication - notably the theorems of Claude Shannon. All use of cell phones, satellites and the Internet should be accompanied by a hymn of gratitude to Claude. Shannon's 10th theorem sets down the primary law governing transparency of communication (transmission).
As far as the fidelity of the message being transmitted is concerned, there are only two possibilities. You either have transparency and communication reliability or you don't. In this affair of transmission fidelity, translucency and opacity are the same thing. There is only transparent and non-transparent. The degree of contamination in the transmission (noise and error) does not much matter. When the institutional hierarchy hears a regulator pontificating about "clearer and more complete" transmission for compliance, it knows devising legal workarounds will be a snap. This is why, exactly, the SEC will not get a flood of anxious commentary from the head sheds rejecting your amendments and defending the status quo.
Obviously, transparency can only be achieved through engineering foresight. Hindsight, at best, can only record what pragmatic foresight accomplished. As Shannon's 10th instructs, transparency is avoiding contamination in advance to every reasonable degree and then arranging spare bandwidth for dynamic error removal. This is, exactly, what Corning had to engineer in transparency to make fiber optics a viable medium of electronic communication. Transparency is a property you engineer in advance for future deployment. It is also obvious that subjectivity anywhere in the transmission process, oblivious to personnel credentials, is a contaminant. Transparency means zero subjectivity in the deliverable. As far as any engineer knows, the only deposit where zero subjectivity can be quarried is natural law. It is the only sanctuary available to us that is free of judgment, opinion and whim – a haven from which we need not retreat – a platform giving the same image to every perspective. The design requisite is simple – complete scrutable connectivity to natural law. There is nothing in the residuum to debate.
The question facing this rule-making about transparency comes down to "Is it practical to provide transparency in institutional operations for internal control over financial reporting?" The answer is "Of course." We had to design the internal control system to Shannon's transparency benchmarks to get it to work right in the first place. To the gang in the boiler room, it is less troublesome to attain transparency than it is to mess around in the ludicrous translucency business. Whenever we get trapped into a do loop with management selecting the degree of translucency deemed appropriate to institutional ideology, the design benchmark is always "I'll know it when I see it." This contamination of subjectivity amounts to a red flag signaling the beginning of the end.
Transparency is respecting natural law in action. It is free, unaltered message transmission over time, verifiable and subject to clear methods of challenge. Transparency erases variability in the interpretation of facts. The means to create transparency and the means to verify transparency are one and the same. In a subsequent commentary, it will be shown that, to the PE, transparency is not an end in itself but a requisite component of the paramount compulsion of engineering workmanship – the self-regulating system.
Regulation meets compliance
The natural laws of systems and dynamics, expressed in a set of equations and algorithms called "control theory," speak to the possible outcomes where the control response is fast and the threat frequency is glacial. When the head shed can neutralize SEC rules in days and the SEC response cycle time is, at best, in years, the intent and content of the rule doesn't matter. By virtue of this gross cycle time mismatch, the initiative, as is and from the perspective of parens patriae, is reduced to an exercise in futility. I doubt if anyone owning a dog in this scrap thinks otherwise.
In order to open the possibility of effective system control, the regulating system must respond to process disturbances faster than the disturbances can destabilize the system. The natural law overseeing this affair in controls is called Ashby's Law of Requisite Variety. Your cell phone contains hundreds of such control strategies all working in synchronization at the same time. In Ashby speak, your arsenal of control options has less variety than the variety institutions have available for compliance. This is the efficient cause why business as usual so readily prevails over regulatory pressures.
Additional commentary will be provided to explain how, exactly, natural law sets absolute limits on the span of competency of institutional process, i.e., business as usual, to deal with variety in the perils and disturbances of right now. While everyone is kept painfully aware of institutional malfeasance encountering these limits, e.g., Katrina, few appreciate the force fields of nature that make it so universal throughout our society. Lastly, the significant leap forward (the future is now), also originating outside of institutional control, driving the erosion of institutional omnipotence through the wormhole of the tort standard of care (foreseeability), will be derived. This set of commentaries provides the SEC with the full engineering context and platform for using pragmatic foresight to assess the impact of its rules before release.
The SEC is commended for providing this convenient, effective means for providing commentary. Your staff handling this electronic system continues to improve the process while it provides excellent service.
William L. Livingston, PE