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Congress Might Take Aim at Backdating Options

September 7, 2006
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Congress may weigh in on the controversy over soaring executive pay by changing a tax rule that experts say has encouraged companies to use stock options in compensation packages.

A bill is unlikely to come up in the short amount of time remaining in the current session of Congress. One might emerge next year as part of a larger tax reform bill or perhaps as part of a measure to close tax loopholes.

But Congress is already turning its attention to executive compensation. Two Senate hearings on September 6—one in the Finance Committee and one in the Banking Committee—explored the issue.

The Finance session featured Internal Revenue Service Commissioner Mark Everson and Linda Thomsen, director of enforcement at the Securities and Exchange Commission. SEC Chairman Christopher Cox testified before the Banking Committee.

Thomsen indicated that the SEC is investigating more than 100 companies for fraudulent reporting of stock option grants.

The Finance Committee focused on a tax provision that limits corporations to a $1 million tax deduction for executive salaries. An exception was made for performance-based pay, which companies can deduct beyond $1 million. Critics say that the rule has contributed to an increase in the use of stock options.

Recent controversy has focused on the practice of backdating options, which occurs when a strike price is retroactively set to a date that would produce a gain for the option holder.

Sen. Charles Grassley, R-Iowa, chairman of the Senate Finance Committee, said that the tax code is "broken" when it comes to executive compensation.

"Companies have found it easy to get around the law," Grassley said. "It has more holes than Swiss cheese. And it seems to have encouraged the options industry."

Modifying the deduction for performance-based pay or tightening up eligibility are options Congress may consider, Grassley said.

Grassley intends to prepare the ground for such legislation by obtaining board minutes from meetings in which companies approved backdating. He also will seek information from attorneys, accountants and compensation consultants who contributed to the decision.

Grassley gave no quarter in attacking pay schemes that lead to bloated executive salaries. "It is behavior that, to put it bluntly, is disgusting and repulsive," he said.

Everson recommended that Congress allow the IRS to share more tax return information with the SEC regarding companies that are suspected of reporting violations. In sometimes passionate testimony, Everson demonstrated his frustration with backdating scandals.

"In the area of corporate governance, the temptation to do the wrong thing is increased when he stakes are as staggeringly high as they are," he said. "I do find it disappointing that the boards of these companies haven’t done a better job of preventing us from getting to (this) point."

Charles Elson, a University of Delaware professor, suggested that board members hold stock in the companies they oversee so that they are more closely linked to their management. He also called for more disclosure regarding compensation consultants and greater shareholder say in board elections.

"There is an overcompensation problem in corporate America," he said. "It has undermined shareholder confidence in the system."

In testimony at a House hearing earlier this year, Thomas Lehner, director of corporate governance at the Business Roundtable, said that the increase in CEO compensation has been consistent with shareholder return.

Mark Schoeff Jr.

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