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Round'em up

Dear friend.

Here’s a shaggy blog story to make you start your Monday morning with a headache so bad you’ll swear never to read an SEC filing again.

Reinsurance has found something intriguing in the annals of the SEC regarding executive remuneration at US brokers Arthur J. Gallagher.

On August 21st 2007 the SEC asked Gallagher this question (amongst others) about its proxy statement of April 2007 :

“You disclose that the performance level of J. Patrick Gallagher, Jr., your CEO, made him eligible to receive an award of up to 150% of his base salary. According to your table on page 16 and related disclosure, it appears that in order for your CEO to achieve a maximum of 150% of base salary, 2006 revenue would have had to increase by 10% or more from 2005. Based on the information filed in your annual report on Form 10-K for the relevant periods, it does not appear that such revenue target was achieved. As such, please clarify how it was determined that your CEO was eligible for an award of up to 150% of his base salary.”

To summarise – the question was – why did they say he was due a 150% bonus when it looked like he wasn’t?

Gallagher replied in a letter dated September 21st 2007:

“In setting the revenue target and in calculating the actual results, the Compensation Committee made two adjustments to revenue as reported in the Company’s 10-K:

“In May 2005, as a result of certain legal and regulatory proceedings, the Company agreed to stop accepting a form of payment known as contingent commissions. This change went into effect at the end of 2005 and was deemed by the Compensation Committee to be outside the control of management. In calculating revenue for purposes of the performance target, the Committee subtracted revenue attributable to contingent commissions from 2005 and 2006 results.

“In 2003, the Company began to wind down its Financial Services Segment. The Compensation Committee determined that it would be appropriate to exclude the impact of these operations from the performance target. As a result, the Committee subtracted revenue attributable to the Financial Services Segment from 2005 and 2006 results.”

But stripping out contingent commissions and the wound-down financial services segment, the increase was still only 9.66%.

So what happened? Back to Gallaghers’ reply:

“Adjusted Revenue increased by 9.66% from 2005 to 2006, which the Compensation Committee rounded to ten percent in determining that J. Patrick Gallagher was eligible to receive an award of up to 150% of his base salary.

“In future filings, the Company will, as appropriate, expand its disclosure of performance targets to clearly indicate when the targets are intended to be measured on an “as adjusted” basis."

Here are the numbers:

Before adjustments the total revenues were $1,484m in 2005 then $1,534m in 2006, an increase of 3.3%.

But stripping out contingents and financial services they were $1,336 in 2005 and $1,465m in 2006, an increase of 9.66%. This was then rounded up to 10%.

What did the SEC think of this?

The SEC wrote back again in November 27th 2007:

“We note your response to prior comment 7 [the Pat Gallagher remuneration question]. In your future filings, as applicable, please provide discussion and analysis of why the Compensation Committee made adjustments to revenues or to other financial metrics for purposes of making compensation awards that are tied to those metrics.”

So, please show your working. No mention of the rounding up, though.

Gallagher replied on December 11th :

“In future filings, the Company will, as applicable, provide discussion and analysis of any adjustments to the financial metrics used to determine compensation awards, including discussion of the rationale for any such adjustments.”

In December the SEC wrote back to say it had no further comment

Very nice work if you can get it. We all wish our own target numbers could be rounded to the nearest whole number too!

But then it all gets a little crazy.

We called AJ Gallagher for comment. The company didn't wish to say anything but referred us back to its proxy statement.

Please take a deep breath!

This is what it says about executive goals and targets for 2006 — (we have tried to make it easy for you with a medals system).

1. “Gold medal”

If in 2006 the Company revenue increases 10% or more from 2005 revenue and 2006 pre-tax income increases 10% or more from 2005 pre-tax income a bonus of a maximum of 150% of base salary is payable.

2. “Silver medal”

If a business unit for which the participant is responsible achieves at least 75% but less than 100% of budget plan revenue and pre-tax income levels, a bonus of a maximum of 100% of base salary

3. “Bronze medal”

If a business unit for which the participant is responsible achieves less than 75% of budget plan revenue and pre-tax income levels, bonus is a maximum of 50% of base salary

It went on to say that in 2006, “the threshold for the paying of awards under the SMIP was met [our underlining, not theirs]. The performance level of J Patrick Gallagher, Jr. made him eligible to receive an award up to 150% of his base salary”.

Just to recap, after adjustments, revenue grew by 9.66% looks like a silver medal deal.

So how much was Mr Gallagher actually paid?

Well, the proxy says his salary was $925,000, but his bonus was $1,000,000.

Now that’s 108%, a bit more than a ‘silver medal’ bonus, but a bit short of a full ‘gold medal’ award. (well the 150% is the maximum bonus, after all).

Truth is always a lot stranger than fiction.

We wonder what was the point of confusing everyone and risking the wrath of the SEC over $75,000? Who knows?

We’ve come to the end of this little tale, and there is no further comment.

The trouble is, we just don’t understand anything any more!

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