Many people can recite the first half of Louis D. Brandeis' quote about the cleansing qualities of disclosure—"Sunlight is said to be the best of disinfectants...." Few bother with the rest of the sentence, in which Brandeis calls "electric light the most efficient policeman." To her credit, Securities & Exchange Commission Chairman Mary Schapiro seems to have both sides committed to memory.
One of the priorities of any SEC chair is to address investor and market concerns before populist anger spurs overreactions on Capitol Hill (think Sarbanes-Oxley). Following the Wall Street bonus binge of '09, Main Street anger over CEO pay is at an all-time high, and before things get too out of hand, Schapiro has put compensation under the lamp.
She and her deputies have used recent appearances at legal conferences to spell out their expectations for full compliance with executive pay disclosure rules. And there's growing anticipation that the SEC will make an example of an uncooperative company or two this proxy season. Schapiro, it should be noted, has a newfound perspective on the power of public exposure: Her former employer, the Financial Industry Regulatory Authority, failed to fully disclose her rich payout of $7.3 million, which some in the blogosphere have derided as being downright Dick Grasso-esque.
Tougher standards were adopted in July 2006 by then-SEC Chairman Christopher Cox, but his lieutenants failed to hold most issuers' feet to the fire on linchpin disclosures related to performance targets and benchmarking. As a result, corporate lawyers began to treat the cops at SEC's Corporation Finance Div. with the kind of respect reserved for Barney Fife—except that given the SEC's limited resources and Cox's failure to provide adequate backup, Corp Fin lacked even the single bullet Sheriff Andy Taylor allowed Barney to carry in his shirt pocket.
The ground started to shift last June when Schapiro proposed post-meltdown pay disclosure changes to focus "further sunshine on compensation decisions." These rules, which call for more information about possible links between pay practices and excessive risk-taking and breakouts of revenues received by "independent" advisers to board pay panels, were adopted in December.
With Schapiro watching their backs, SEC staffers started acting a lot more like Dirty Harry, uttering "make my day" warnings to issuers and their advisers. In a Nov. 9 speech, Corp Fin Deputy Director Shelley Parratt reset the bar for 2010. "Our expectations for quality disclosure are heightened," Parratt said. "We expect companies and their advisers to understand our rules and apply them thoroughly." Overnight, scores of lawyers dashed off client memos transforming Parratt's words into what now passes for a backwards Miranda warning: Anything you don't say can and will be held against you.
After years of the SEC handing out "incomplete" grades and making head fakes, it appears the new sheriff really means business. Company advisers report that SEC staff is providing swift pay-related feedback—even on preliminary proxy filings—and most companies are making changes in response. "A lot of companies that I've talked with are beefing up their disclosure," noted one SEC alumnus who advises boards. Upgraded compensation-related proxy disclosures, with more graphs and charts detailing the link between pay and performance, are flowing into the SEC's mailbox, based on what I've seen posted on its EDGAR Web site.
Last May, Warren Buffett told the attendees at his annual "Woodstock for Capitalists" that the best way "to get big shots to change their behavior" surrounding executive pay "is to embarrass them." It appears that the mere threat of humiliation does the trick just fine, though a few companies are certain to dig in their heels.
The context of Brandeis' sunlight insight is often forgotten. Contrary to popular wisdom, the reference isn't from a court decision. It was buried in a series of 1913 Harper's Weekly articles that focused on—you guessed it—banking reform and the failure of corporate governance. Those essays were collected into a 1914 book titled Other People's Money. How appropriate.