Proxy Hysteria Coming For Companies With DB Plans

You read it here first. During the upcoming proxy season, there is going to be hysteria over the executive compensation disclosures in proxies for companies with defined benefit (DB) plans, especially those with nonqualified plans for their named executive officers (NEOs).

What's going on? As part of an NEO's compensation, filers are required to include the increase in the actuarial present value of DB plans. The actuarial present value is a discounted value of the anticipated payment stream just as it was a year earlier. While there are many assumptions that actuaries select in determining an actuarial liability, two, in particular, have changed for many companies from 12/31/2013 to 12/31/2014. One is the discount rate which will have decreased by somewhere in the neighborhood of 100 basis points and the other is the mortality assumption. Late last year, the Society of Actuaries (SOA) released its newest mortality study and many companies elected to adopt the new tables.

The effect of the change in discount rate will vary, largely on the age of the NEO in question, but it's not unreasonable to think that for most NEOs that just that discount rate change will have increased the actuarial liability attributed to them by 8%-12%. Yes, Americans are living longer. Mortality assumptions should be updated from time to time. But, for proxy purposes, the year of the update causes an additional spike in the liability attributed to the individual NEO, perhaps an additional 5% depending upon age and gender.

So consider an NEO whose 2013 compensation included $1,000,000 due to the increase in the actuarial present value of accrued pension benefits. If that person is still an NEO at the end of 2014, he or she will have had an increase in liability due to surviving one more year (interest and mortality totaling perhaps 6%), an increase due to increases in included compensation (a large bonus could have increased even 3-to-5 year average compensation by 25% (recall that in the case of a 5-year average that 2014 which was a good year for many businesses replaces 2009 which was a dismal year for many businesses)), and increases due to changes in discount rates and mortality assumptions.

So, with no changes in compensation practices, our NEO who had $1,000,000 of compensation attributable to him or her in 2013 might see that turned into an increase of $1,500,000 in 2014.

There will be outrage. Proponents of the pay ratio rule of Dodd-Frank Section 953(b) will point to these increases and say that the rank-and-file got 2%-4% increases. The media will not understand what happened. Congress, and this might be the year that it matters as the new Republican control has suggested that it will try to repeal some parts of Dodd-Frank, will not understand.

But those people who chose to read my ramblings will get it. Companies that foresee the issue can address it. It can't be solved in its entirety, but it can be managed.

I know how.

Do you?

PCAOB Expands Purview of Accounting Profession to Review Compensation Arrangements

Unless you are in a field related to accounting or review of public companies, you may never have heard of the PCAOB, or more formally, the Public Company Accounting Oversight Board. It is actually a private-sector, non-profit company that was created by the Sarbanes-Oxley Act (SarbOx or SOx) in 2002. According to SOx, the PCAOB is to, among other things, oversee the audits of public companies. In part, to do so, the PCAOB creates a set of auditing standards that must be approved by the Securities and Exchange Commission (SEC).

Got that?

So, why am I writing about this? Earlier this year, the PCAOB issued Auditing Standard 18. In late October, the SEC approved it. And, so it is.

Auditing Standard 18 (AS18) is a lovely document. It's 223 pages of, and I can't think of a better word for it, stuff carrying the clearly far too brief title, "Related Parties and Amendments on Significant Unusual Transactions and a Company's Financial Relationships and Transactions with its Executive Officers."

Got that as well?

Among other things, AS18 asks that auditors, among other things:

1. Read the employment and compensation contracts between the company and its executive officers
2. Read the proxy statements and other relevant company filings with the SEC and other relevant regulatory agencies that relate to the company's financial relationships and transactions with its executive officers
3. Obtain an understanding of compensation arrangements with senior management other than executive officers including incentive compensation arrangements, changes or adjustments to those arrangements, and special bonuses
4. Inquire of the Chair of the Compensation Committee as well as outside compensation consultants
5. Obtain an understanding of expense reimbursement policies with respect to executive officers

All of this is to be done to identify risks of material misstatement.

I understand why all of this is being done. Early in this century, there were a number of corporate scandals resulting from apparently fraudulent misstatement of financials. Many of you remember Enron, WorldCom, and Tyco. This is intended to be one more step to lessen the likelihood of such abuses and to restore faith that corporate America, as a whole, are being good citizens.

We place lots of faith in auditors in this regard. Now, I have friends and acquaintances who are auditors. Some of them are very good and knowledgable. And, this is not intended to say that the rest (the complement of some of them) are not good, but in any profession, some practitioners will always be better than others.

Here, however, the PCAOB and the SEC are either assuming that auditors have sufficient expertise in compensation arrangements to handle this undertaking or that the firms of which they are a part have this expertise internally to which the auditors may refer. At the Big 4, this is probably the case. They have massive staffs and are able to engage specialists to handle such complex questions. How about the next tier of auditing firms? Do they have this expertise? I don't know, but I suspect the answer is sometimes. Let's take it down one more tier. Do those firms have that expertise? Again, I'm guessing, but I suspect that the answer is not very often. And, if we move to the smallest of the auditing firms, I would be inclined to move the needle to rarely, if at all.

Most auditors that I know are nice people. Most auditors that I know are pretty smart. Most auditors that I know are pretty honest. That said, most auditors that I know are being asked here to weigh in on matters in which they have no training and are frankly not likely to have it anytime soon.

What is the answer? I'm not sure. I'm not a fan of more regulation or more government control generally, but perhaps people who engage in review of compensation arrangements of public companies need some sort of licensure. Actuaries need it for many functions that we perform and we are also, as a group, pretty nice, smart, and honest.

I think that the PCAOB and SEC have used their unencumbered power to stretch too far. Perhaps, it's time to rein them in?

The Accidental Fiduciary

Lots of people in business aspire to be on a corporate board of directors. It's a position of power. It's a position of prestige. You get to rub elbows with movers and shakers. Depending upon whose board it is, you may get paid a lot of money. And, you may be an accidental fiduciary in a retirement plan.

What was that? What did you say, dear blogger author person? Did you just tell me that being on a corporate board could saddle me with fiduciary responsibilities in a corporate retirement plan? Doesn't that mean that I am mutually and severally responsible for ensuring that what goes on in the plan is done in the best interests of plan participants?

How in the world did this happen?

You may recall that earlier this month I posted about the dangers of boilerplate work. Back then, I did it in the context of providers bidding low amounts to provide services and then providing you with exactly the same work product they have given to everyone else. It's not just consultants, some attorneys do this as well.

Just last week, I was speaking with an attorney friend of mine (yes, even an actuary can have an attorney friend or two). He warned me that this was going on and while I was not surprised to hear it, I was a little surprised with regard to the specific context.

And, then I saw it. With my own two eyes, aided by some pretty spectacular reading glasses, I saw it.

The Plan Committee shall be responsible for the operation of the Plan. The Board of Directors, or if so specified by the Board of Directors the Compensation Committee of said Board, shall be responsible for the selection of said Committee.

Bam! That's how a Board member can become a plan fiduciary and be legally and financially responsible for the actions of that plan committee.

Maybe being a corporate board member has some downside, too.