Simple Math Stumps US Corporations - SEC Rides to the Rescue

Our Corporations Isn't Learning

As you'll recall, Section 953b of the Dodd Frank Act requires corporations listed in the USA to publish a ratio of the total compensation of the CEO to the median compensation of all other employees (excluding the CEO).

Self-proclaimed "captains of industry" objected to the onerous requirement of providing this ratio, but their pleas were ignored --though implementation was delayed till 2017.

Now with a kindler gentler administration in the White House and control of both the House and Senate in the hands of the GOP, they are getting a second hearing.

February 6 Acting SEC Commissioner Michael Piwowar:

The Commission adopted the pay ratio disclosure rule in August 2015 to implement Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The rule requires a public company to disclose the ratio of the median of the annual total compensation of all employees to the annual total compensation of the chief executive officer.

Based on comments received during the rulemaking process, the Commission delayed compliance for companies until their first fiscal year beginning on or after January 1, 2017. Issuers are now actively engaged in the implementation and testing of systems and controls designed to collect and process the information necessary for compliance. However, it is my understanding that some issuers have begun to encounter unanticipated compliance difficulties that may hinder them in meeting the reporting deadline.

I encourage commenters and the staff to expedite their review in light of these unique circumstances.

Boldface above courtesy of AA.

Yes, this is indeed an almost insurmountable task. 

1. One has to figure out the total compensation of the CEO.  Oh, wait.  That's already done for the annual Proxy Statement. 
2. Then one has to figure out the median salary.  That's even more tricky because it involves two really "hard" steps.  
3. Big corporations have operations all over the world and pay their employees in a myriad of currencies.  How possibly could they figure out the US equivalent of Paris-based Jacques' salary or Frankfurt-based Heinrich's?  Oh, wait.  Corporations routinely convert local currency transactions into US dollars for their annual financial reports, including salaries paid to foreign workers.  Corporations also routinely keep detailed employee by employee payroll records for tax, pension, and other purposes so no new records have to be created.  What probably would be required is to add a column to figure out the US dollar equivalent salary for each employee.  
4. But, as no doubt many a beleaguered corporation will point out, then they have to figure out the median salary.  What's a median? An extremely challenging task.  One lists all salaries and then picks out the one that is smack in the middle.  This is the sort of things that computers were made to do.  Microsoft's Excel has a preprogrammed "median" function so this is definitely not rocket science.
5. So the corporation would have to consolidate US dollar-equivalent lists of salaries prepared by various operating units (foreign and domestic) and then sort them by amount and pick out the median.  Another automated process.

On its face, it sure looks like this objection is motivated by a desire to avoid providing this information because it's likely to raise uncomfortable questions about CEO compensation.

But, let's accept the manifest absurdity of this argument and assume for a moment the objection is true.  After all, we have a new Treasury Secretary who swears he can't fill out government ethics forms and other members of the Administration see things that never happened (3.5 million people at the Mall for the Inauguration, 3.5 million illegal voters, etc). 

On that score Mr. Piwowar "understands" that some corporations are having a problem.  It's not clear if there have been many complaints from companies, whether he is seeing things, heard about it from KellyAnne, or read about it on Breitbart.

Rule 953b was finalized 5 August 2015. 

That means that some US listed corporations have been unable to establish a system to calculate this ratio in the 17 months since then and believe that they will be unable to complete it in the additional 11 months remaining during this year (assuming most corporations have a December fiscal year end).

If this is the case, then 3 troubling questions.

1. In an era where complex calculations are at the base of product development and production, should a consumer purchase a product from a company that acknowledges its inability to do simple maths?
2. In an era where proper pricing of products, operations and risk management depend on the ability to perform complex calculations, should an investor buy the stock or bonds of a company that admits that simple mathematical procedures exceed its competence?
3. Should the average citizen and our government be worried that our self-proclaimed math-challenged corporations are clearly not equipped to compete with foreign corporations?

The SEC is taking comments on implementation of this rule.  Let your voice be heard.

SEC to Rely on FINRA to Monitor Brokerages

"Daddy, read me the story of the self-regulating market again"

If your daddy didn't read you this fairy tale when you were young, maybe your "Uncle" Milton told it to you at university.  Or a kindly professor relayed the Uncle's wisdom to you. 

If this didn't happen, here's a quick recap. 

Even if each businessman single-mindedly pursues his or her own profit to the exclusion of all other concerns, where there is intense competition of the "free" market (note that requirement) salutary outcomes result:

1. individual or overall market excesses are magically curbed 
2. firms offer the best service and prices, eventually competing profits away to zero unless, of course, they make improvements to products.  [Because profits never go to zero (except in bankruptcy) this no doubt proves the creative power of free markets to constantly improve products.]
3. those firms that do not lower their prices or improve their products are forced out of business

Since by definition, the market in the USA is not only "free" but "intensely" competitive, then with such miraculous powers there is little if any need for government regulation.  In fact by interfering with the market, governments are liable to do more harm then good as this quote attributed to Mitt Romney demonstrates. 

The invisible hand of the market always moves faster and better than the heavy hand of government.

This theory seems to be the rationale for this recent SEC decision reported this Monday by Reuters.

The Securities and Exchange Commission is leaning more heavily on partner regulator the Financial Industry Regulatory Authority to monitor brokerages as it devotes extra staff to oversee the rapid growth of independent financial advisers, a top regulator said Monday

What could possibly be a reasonable objection to FINRA taking over SEC duties?

Simply put, FINRA is an industry group and therefore has an inherent conflict of interest. 

Does this mean that it is certain that they will fail to do a proper job or that they have failed in the past?  No.  What it does mean is that a conflict could cause them to fail.

What are some of the potential trouble "spots"?

1. Setting professional qualification standards too low.  FINRA doesn't report the pass rates on its qualification exams (Series 7, etc).  The pass rates for the CFA, CFP, FRM are all reported and suggest these certifications are difficult to obtain.  Why is that?   
2. Restricting information on actions against brokers.  If you'll recall a while back, FINRA was criticized for failing to provide enough information in its Broker Check (BC) tool to allow investors to determine whether to work with a particular broker.  FINRA announced some improvements but just recently the  Public Investors Arbitration Bar Association found those improvements lacking and criticized FINRA because BC doesn't include reasons for a broker's termination by a firm, information about bankruptcies, tax liens and scores on relevant industry examinations.  PIABA noted that some of this information is provided by state security regulators (government agencies) which suggests (but does not prove) that legal liability issues did not motivate these omissions.  
3. Applying a light touch on penalties when perhaps a heavier one is justified.  In the past the maximum fine was $15,000 per "offense" in the NASD days. (FINRA is the combination of the "old" NASD and NYSE separate self-regulatory bodies).   This has changed. Fee levels have increased.   In 2016 FINRA is set for a record year of estimated fines of some $160 million due to some "supersized" fines.  ("Supersized" is defined as a fine $1 million or more).  The estimated 2016 total fines is less than the fines levied against Wells Fargo by government regulators for the "fake accounts" scandal. The last time I looked FINRA's largest 2016 fine was some $25 million against Met Life (2015 revenues $70 billion net income $5 billion).  See the analysis of these "ginormous" fines by Sutherland Asbill and Brennan here.  And here for K&L Gates' analysis of 2015 fines in which it's noted that most FINRA actions are resolved for less than $50,000.  It should be noted that FINRA fines individuals as well as firms and that many of the firms in the industry are minnows alongside the major brokerage firms so $50,000 could be a firm threatening fee. 

Just to be clear, I am not accusing FINRA of improper behavior.  I am merely pointing out a conflict of interest.

During his illustrious career, AA has seen a lot of conflicts of interest turn into conflicts of action. 

Here's one "sweet" story - not witnessed by AA.

Early warning signals of the coronary heart disease (CHD) risk of sugar (sucrose) emerged in the 1950s. We examined Sugar Research Foundation (SRF) internal documents, historical reports, and statements relevant to early debates about the dietary causes of CHD and assembled findings chronologically into a narrative case study. The SRF sponsored its first CHD research project in 1965, a literature review published in the New England Journal of Medicine, which singled out fat and cholesterol as the dietary causes of CHD and downplayed evidence that sucrose consumption was also a risk factor. The SRF set the review’s objective, contributed articles for inclusion, and received drafts. The SRF’s funding and role was not disclosed. Together with other recent analyses of sugar industry documents, our findings suggest the industry sponsored a research program in the 1960s and 1970s that successfully cast doubt about the hazards of sucrose while promoting fat as the dietary culprit in CHD. Policymaking committees should consider giving less weight to food industry–funded studies and include mechanistic and animal studies as well as studies appraising the effect of added sugars on multiple CHD biomarkers and disease development

Why take a risk with this conflict of interest? 

FINRA has a role to play.  

But should the SEC cede what is properly a government responsibility?