How The SEC Got DB Plans All Wrong

Yesterday, I wrote that the SEC contributed to the downfall of defined benefit (DB) plans. I promised to explain in more detail in a future post.

Well, the future is now (I wonder if anyone else ever used that line before).

As readers of this blog well know, for about 10 years, issuers of proxies under the auspices of the Securities and Exchange Commission have been required to disclose compensation for their five highest paid employees. This compensation has been disclosed in a little beast known as the Summary Compensation Table and in more detail in several other places.

Some of the disclosure makes sense. For example, the salary that an individual actually receives is what it is. There is no disputing that. Similarly, the matching contribution that an individual receives in her 401(k) plan or in the nonqualified analog is what it is.

Some of the disclosure makes less sense. Fingers point to the defined benefit disclosures.

What the rules ask be disclosed as compensation with respect to a defined benefit plan (qualified or nonqualified) is the increase, if any, in the actuarial present value of accrued benefits from one measurement date to the next. That seems simple and reasonable enough on its face, but that is exactly where, how, and why the SEC went wrong.

Let's make up some Illustrative numbers for Well Paid Executive who we will refer to as WPE.

• Total pension accrued benefit as of 12/31/2014: $1,000,000
• Total pension accrued benefit as of 12/31/2015: $1,100,000
• Actuarial present value "factor" as of 12/31/2014 using 2014 discount rates and 2014 mortality table: 11.00
• Actuarial present value "factor" as of 12/31/2015 using 2014 discount rates and 2014 mortality table: 11.50
• Actuarial present value "factor" as of 12/31/2015 using 2015 discount rates and 2015 mortality table: 12.50

So, the actuarial present value of WPE's defined benefit as of 12/31/2014 was 11*1,000,000 or $11,000,000. 

The actuarial present value of WPE's defined benefit as of 12/31/2015 was 12.50*1,100,000 or $13,750,000.

The compensation due to defined benefits that must be reported for WPE was 13,750,000 - 11,000,000 or $2,750,000.

But, this is not an apples to apples comparison. Really Big Company (RBC) did not actually compensate WPE for the fact that interest rates on bonds declined during the year. RBC also did not actually compensate WPE for the fact that the Society of Actuaries had finished a new mortality study. 

The actuarial present value of WPE's defined benefit as of 12/31/2015 using 2014 actuarial assumptions was 11.50*1,100,000 or $12,650,000. This means that the increase, on an apples to apples basis, in the actuarial present value of WPE's defined benefits was 12,650,000 - 11,000,000 or 1,650,000. The other 1,100,000 was due to changes in actuarial assumptions and DOES NOT REFLECT THE AMOUNT THAT RBC PAID WPE DURING 2015.

The SEC's methodology has thrown proxy disclosures out of whack. In light of Dodd-Frank and its Say-on-Pay requirement and Pay Ratio Disclosure requirement, the SEC methodology puts an inappropriate burden on companies sponsoring DB plans. For some, this may signal a reason for them to exit that space ... for all the wrong reasons.