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Cox Says Executive Compensation Rules May Address Back-Dating of Options

The SEC's final rule on executive compensation is likely to address the issue of back-dated options, according to SEC Chairman Christopher Cox. In remarks to the New York Financial Writers Association, Cox said the staff is currently considering further adjustments to the proposal to deal with the back-dating of options as well as any other changes that may be needed. He expects the rules to be adopted in time for next year's proxy season. Cox's remarks were posted on the SEC's Web site.

The practice of back-dating options refers to the selection of a grant date for an option award that precedes the date on which the award was granted. Cox explained that this practice must be properly disclosed and properly accounted for under the SEC's current rules. The problem with back-dating options is that it eliminates the direct connection to future performance that stock options otherwise may provide. It also increases the costs of a company's compensation program. 

Cox said companies usually back-date options because the stock price was lower at an earlier date. However, if the back-dating hides compensation from shareholders it can have serious accounting, tax and securities law implications. The back-dating may violate the terms of the company's stock option plan. In other cases, companies may have fraudulently misrepresented the date on which the options were actually granted. Cox said it is clearly wrong to mislead shareholders about the level and form of executive compensation.

The SEC's proposed executive compensation rules will provide better and more useful disclosure about the back-dating of options, according to Cox. Companies would be required to clearly disclose the portion of executive compensation that results from in-the-money option awards due to back-dating. The full value of an option will have to be disclosed based on the date the award was actually made, he said. The rules would also require a comparison of the exercise price of the option to the grant date market price of the option whenever the exercise price is lower than the market price. That will enable investors to see the additional compensation that was given to executives when the option was granted. The plain English element of the rule will help investors understand how a company decided when to make its options awards, Cox added. 

The staff is also considering whether additional guidance is needed with respect to the back-dating of options. Cox said the staff should soon make a recommendation to the Commission at an open meeting. If the rules are adopted, Cox predicted that the debate over CEO compensation will intensify. Shareholder activists will have new opportunities to call for better discipline, he said, and interested parties will be able to more accurately calculate the ratio of average worker-to-boss compensation. Improved access to information is a form of public participation in decision-making, in his view.