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Commentary;  CEO Politics
The Wall Street Journal
Tuesday, January 9, 2007

For an excellent example of why federal agencies so rarely admit mistakes, look no further than the recent uproar over the Securities and Exchange Commission's flip-flop on stock-option disclosure. House Financial Services Chairman Barney Frank is already planning to ride this error through the next election as part of his campaign against CEO pay.

The SEC has been under attack since it announced -- on the eve of Christmas weekend -- that it was modifying its July disclosure rule on executive compensation. The commission's new order tweaks the way stock option grants are disclosed, with the goal of making total annual compensation figures more accurate and consistent. Chairman Christopher Cox admitted that the SEC had inadvertently adopted the wrong version of one part of the rule, and was simply trying to set things right.

That mea culpa counted little with Mr. Frank, who denounced the SEC for loosening reporting requirements to provide a "Christmas Eve" gift to corporate America. He also declared that this "backtracking" by the agency meant his committee now had an obligation to dive into the "problem" of "unconstrained" executive compensation -- as if he needed an excuse.

This political opportunism is especially unfortunate because the new SEC rule is entirely in keeping with Mr. Cox's goal of bringing more "clarity and consistency" to corporate pay disclosure. Even Mr. Frank praised the SEC's decision last year to require companies to aggregate all of their top executives' compensation -- pay, bonuses, perks, options -- into one bottom-line figure. When these reports begin to become public later this year, investors will get a better look at management costs and be able to compare those numbers across companies.

Under the flawed SEC rule, companies would have had to include, in their annual total compensation reporting, any stock option grants awarded during the year. This would have been highly misleading to the extent such grants weren't yet exercisable and thus might never be "in the money." Under the new rule, companies will instead include any options that actually vest that year -- meaning options that executives can truly turn into cash or stock.

Contrary to most media descriptions, the new rule won't necessarily result in lower reported compensation numbers. Under the old rule, a big grant would only appear in the year it was awarded, then disappear in subsequent disclosures. Under the new rule, the final figure will include any and all previous option awards that vest in that year -- leading, in many cases, to more substantial bottom-line figures. Meanwhile, information about big annual option grants is still readily available to investors, albeit in a different section of the SEC compensation form.

This change will also harmonize the new compensation disclosure forms with other corporate financial statements. Under current accounting rules, companies only expense options in their financial statements as the options become exercisable. Given that the SEC's goal with its disclosure rule was to make compensation figures more consistent and understandable for investors, it would have made little sense to set up two completely different ways of counting options.

The SEC's mistake is regrettable, but the agency might be forgiven for overlooking what was a relatively minor point in its gigantic 450-page July rule. And one reason it didn't hold a public meeting on the new amendment is that all five SEC Commissioners -- including its two Democrats -- unanimously agreed that the change was necessary.

Mr. Frank surely knows all this, but he is hunting bigger political game -- namely, running against "excessive" CEO pay and alleged "inequality" as Democrats gin up a campaign issue for 2008. The left believes its neo-populism paid off in November's election, and it wants to ratchet up the rhetoric this year in Congress.

As part of his investigation, we can only hope Mr. Frank explores the role that the last Democratic Congress played in encouraging CEO stock option grants by limiting to $1 million the amount of executive cash compensation that companies could deduct from taxes. (Bob Nardelli, Frank Raines and Hank McKinnell, among others, are grateful.) But then again, that would mean admitting that Congress made a mistake; it's so much easier to demagogue CEOs and the SEC.