On July 26, 2006, the U.S. Securities and Exchange Commission approved several new rules aimed at increasing transparency in executive compensation. These new rules will go into effect on December 15th, 2006 making them mandatory filings this year for all corporations that follow the calendar year.

The new rules are designed to combat several holes in the old reporting requirements that allowed executives to hide or obfuscate income in bonuses, options, grants, and other financial instruments. The SEC plans to combat these practices by requiring companies to include detailed narratives alongside tabular data in an effort to aid investors and curb overcompensation in corporate America. These narratives would require companies to explain exactly what compensation is being given under what circumstances in a language that average investor can understand.

Both investors and employees have been demanding such reforms, as executive salaries continue to reach new highs while employee salaries remain nearly flat. One of the main contributors to the magnitude of problems seen today was Regulation 162(m), which was actually developed to curb compensation. In effect, this rule made it permissible for companies to deduct performance-based bonuses on their taxes. This apparent loophole quickly led to scenarios in which executives would be compensated for vague and intangible performance measures like diversity, customer service, employee morale, and others. Companies could easily inflate these numbers without drawing suspicion and dish out millions to executives.

The newly approved disclosure rules put a ban on such vague definitions by requiring detailed narratives to accompany any form of compensation – including bonuses. These narratives are to be present in a new section of any company’s 10k filing or proxy statement, entitled “Compensation Discussion & Analysis”. This section will not only include a detailed overview of the objectives and implementation of all compensation, but also assurance of compliance by a newly required “Compensation Committee Report”.

The SEC also made several other smaller adjustments to reporting requirements that assist individual investors in evaluating executive compensation. Most notably, they enhanced the tabular data to include dollar values for stock option grants and other more obscure forms of compensation. Secondly, they now require certain employment related details to be disclosed in 8K statements under a single item. And finally, they require disclosure for up to three employees who were not executive officers during the last completed fiscal year, but whose total compensation was greater than that of any named executive officers.

Combined, these new regulations make it even more difficult for executives to legally conceal their pay. Hopefully along with these reforms, we will see more moderate executive pay and fairer compensation for both employees and stockholders.

The official SEC rules are available here: http://sec.gov/rules/final/2006/33-8732a.pdf