Cox speech on executive comp disclosure

By Cydney Posner

You might be interested in some comments about proxy disclosure under the new rules made recently by SEC Chairman Christopher Cox in a speech to a Corporate Governance Summit at USC.  To read the speech, click here.

With regard to the plain English requirement, Cox observes that "alarm bells are ringing. Already we're seeing examples of over-lawyering that are leading to 30- and 40-page long executive compensation sections in proxy statements." Cox attributes the problem, not to the complexity of the SEC's own requirements of course, but rather to lawyers' needs to erect "a sturdy defense against potential claims that something was left out or improperly expressed."

According to Cox, an IR firm analyzed 40 companies' CD&As for their level of compliance with the plain English requirement, determining that all 40 of them fell "far short of accepted standards of readability. In fact, they found that most of the disclosure documents failed even to meet the readability standards that states require for insurance forms."

First, the disclosures were too long, with the median length for the CD&A of 5,472 words and the longest being more than 13,500 words, longer than a full-length feature in the New Yorker. Amusingly, Cox notes that the SEC "had it in mind that they'd be just a few pages long." (Of course, these rules were brought to you by the same folks who initially estimated that the cost imposed by SOX 404 (internal control) for outside professionals would average approximately $34,300 per company!)

Ok (she notes grudgingly), there may be some merit to his argument. Apparently, there are some "readability" models, linguistic tools that measure the readability of English prose, based on sentence length and the number of complex words. Under the Gunning-Fog index, writing that's aimed at a general audience should have a Fog Index number of less than 12. The WSJ scores between 11 and 12, while Readers' Digest scores an 8. However, the average Fog Index for the CD&As in the sample was 16.45 (with a maximum on the scale of 17), about the same as an academic paper or a Ph.D. dissertation. Of the 40 companies in the sample, 15 maxed out at 17, and the most readable CD&A in the group came in at 14.02.

The results were even worse using the Flesch Reading Ease test, essentially an algorithm that computes readability based on the complexity of the words used (the average number of syllables per word) and the average number of words per sentence. With scores ranging from 0 to 100 (with 100 being the best), Readers' Digest averages about 60 to 70 and, under state standards, insurance forms typically must score between 40 and 50. In the sample of 40 proxy statements, the average CD&A score was just 34.86. Although Cox acknowledges that, like "the grammar check in Microsoft Word, they wouldn't recognize poetry if they saw it," the SEC's own review (and we all know how well the SEC writes) concluded that we have a long way to go.

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