The Advisors' Blog

– Broc Romanek, CompensationStandards.com

Here’s a blog by Pearl Meyer & Ptrs’ Greg Swanson:

While most of the chatter surrounding the SEC’s April 29 proposed rules appears to be focused on the recalculation of equity values, the proposed change in the way pension values are reported for pay-versus-performance disclosure is equally significant for those companies that sponsor defined benefit (DB) plans. When defining “compensation actually paid,” the SEC acknowledged the inadequacy of the current definition of Change in Pension Value in the Summary Compensation Table (SCT). As a result, the SEC is proposing that the pension value currently used in the SCT be replaced with the actuarially determined “service cost” for the applicable fiscal year for purposes of the pay-for-performance disclosures.

By its proposed adjustment, it appears the SEC is now in agreement with the rest of us. To understand the relevance of the proposed adjustment, it might help to explore the flaws in the current SCT disclosure rules.

Communicating the compensation value of widely different DB retirement arrangements is challenging – a fact the SEC readily admitted when developing the current DB plan compensation disclosure rules that became effective in 2006. In an attempt to standardize the method of disclosure and minimize the burden placed on companies, the SEC decided to require the disclosure of an annual value that loosely reflects the increase in the accounting liability for most DB plans. There are two fundamental flaws in the DB plan values currently required in the SCT:

1. The SEC’s method for disclosing DB plans in the SCT includes all interest cost (growth in value due to the passage of time) as compensation to the executive. This is in direct conflict with the SEC’s own determination that reasonable interest earned on voluntary deferred compensation should not be considered current compensation for purposes of SCT disclosure.

We agree with the SEC that only “preferential” interest should be considered compensation. Applying this in a consistent manner to DB plans would mean that the interest cost associated with prior accrued benefits should not be included as compensation. As a result, the SEC’s method for the SCT could materially overstate DB plan compensation in the latter years of an executive’s career.

2. The SCT method also includes as compensation 100% of the value of any actuarial gains or losses resulting from changes in assumptions (e.g. discount rate, mortality table), as well as the full impact of any plan amendments that occur during the year. This can result in significant fluctuation in calculated value from year to year, diminishing the comparability of the information between years and/or between individuals.

Replacing the SCT DB pension methodology with an actuarial service cost approach, as the SEC has proposed, would address both of these fundamental flaws and result in a much more consistent, apples-to-apples compensation value associated with DB plans. Our firm often employs a similar approach when performing total compensation benchmarking analyses for clients if they, or their peers, maintain DB retirement arrangements for executives. This can be particularly important for companies in industries with a higher prevalence of DB plans such as banking, insurance, utilities, manufacturing, etc.

We applaud the SEC for making this adjustment to the definition of “compensation actually paid,” and believe the SEC should go a step further and overhaul the methodology within the SCT in the same manner. This would minimize the confusion of multiple methods and provide shareholders with pension-related compensation information that is more relevant, comparable and useful.