(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

Pitt Calls for Reform of Options, Corporate Governance

In a recent address, SEC Chairman Harvey L. Pitt cited a need for improvement in corporate governance and for stricter controls on the issuance of stock options to senior management. He stated that the Commission’s primary concern with stock options is to ensure that management’s interests are aligned with shareholders’ interests. The chairman discussed the role of stock options and how they can create conflicting interests if company executives profit while shareholders lose money. The key, according to Mr. Pitt, is to ensure that a company, if it chooses to grant stock options, creates incentives that make the options actually work as intended rather than creating an unearned windfall for managers. With regard to corporate governance, he noted that the best way to improve current standards is to make certain that officers and directors have a clear understanding of their roles and to apply serious consequences to those who do not live up to their fiduciary obligations.

Stock Option Grants

Mr. Pitt suggested several specific approaches relating to stock options. He indicated that stock option plans for officers and directors should be approved by shareholders and the decision to grant options to senior management should be entrusted to a committee of independent directors and, specifically, to a formal compensation committee. Moreover, such a committee should have the same authority over compensation matters that audit committees have over financial matters and reporting.

According to the chairman, corporate boards should consider whether officers and directors should be required to demonstrate long term growth and success before being permitted to exercise any of their options. He also noted that the CEO should certify to shareholders that the company has disclosed all necessary information to investors in an understandable format.

Corporate Governance

The chairman, noting that a lack of meaningful and cohesive corporate governance reform has dramatic consequences, commented that he has devoted considerable attention to the ways corporate governance could be improved. "Corporate governance impacts the quality of financial statements and the stability of exchange-listed companies," advised the chairman. As a result, the Commission has asked the New York Stock Exchange and Nasdaq to review their corporate governance and listing standards, officer and director qualifications, and codes of conduct of public companies. The Commission has also asked Financial Executives International to review its code of ethics.

The chairman stated that audit committees need to understand the company’s critical accounting principles and urge ongoing improvement to its systems of internal controls. Audit committees should also be free to hire their own independent counsel and experts when needed to enhance the quality of corporate disclosure. In addition, continued Mr. Pitt, whether the audit committee should be vested with the initial decision about which firm is recommended to shareholders should also be explored. Committees should have the authority to fire outside auditors or prevent management from firing them.

Mr. Pitt commented that he has asked the NYSE and Nasdaq specifically whether audit committees should be vested with the sole authority for assessing the quality and independence of their companies’ outside auditors and what additional functions their auditing firms should perform. The chairman also cautioned that "we should, of course, be careful not to overreact, not to regulate for regulation’s sake and especially not to adopt regulations that run significant risks of doing more harm than good."