Securities & Corporate Governance Monthly - SEC Issues Executive Compensation Report
On
October 9, 2007, the Securities and Exchange Commission (SEC) issued an official report, Staff Observations in the Review of Executive Compensation Disclosure, discussing its initial review of the executive compensation proxy disclosures
of 350 public companies for compliance with the SEC’s new executive compensation disclosure rules. The SEC focused on larger companies during its initial review and issued individual comment letters to each company it
reviewed. Most of the SEC comments were in the form of “future filings” comments, requiring companies to deliver written confirmation that they will comply with the comments in future filings together with an explanation
explaining how they intended to do so. The SEC comments that required additional supplemental information were largely limited to the failure of the company to explain how competitive harm would result from disclosure of the
company’s performance targets as discussed below. In a few instances, the SEC requested that a company revise or enhance its disclosure by amending the proxy statement containing the inadequate disclosure.
The SEC’s official report highlights the two principal themes that emerged from the staff’s review of the executive compensation disclosures. First, the SEC stated that the Compensation Discussion and Analysis
often lacked sufficient analysis regarding “how” and “why” a company arrived at its executive compensation policies and decisions. Second, the SEC stated that companies must focus on presenting the
disclosures in a way that is clear, concise and understandable to the reader.
“WHERE IS THE ANALYSIS?"
On October 9, 2007, John W. White, Director of the SEC’s Division of Corporate Finance, delivered a speech summarizing his assessment of and echoing the comments and observations in the SEC’s official report published
earlier that day. In his speech, Mr. White emphasized that lack of meaningful analysis in the Compensation Disclosure and Analysis is the biggest shortcoming of the proxies reviewed thus far, stating that “We found
ourselves asking this question over and over again: Where is the analysis?” The SEC’s official report and Mr. White’s speech reflect the key topics recurring in the SEC comment letters:
- Components of Compensation and Differences in NEO Compensation. The staff is requesting analysis regarding why the company chose to pay each level and form of compensation for named executive officers (NEOs)
and how the company arrived at that particular level and form of compensation. The staff is also requesting better disclosure and analysis regarding the differences in the amount of compensation among the NEOs and requesting
that the company explain the difference in pay between the CEO and other NEOs. The staff is requesting a company provide more than a discussion of the company’s compensation philosophies by analyzing how such philosophies
resulted in each level and form of compensation paid.
- Change of Control and Termination Payments. The staff is requesting explanation regarding how the company determined that the disclosed payment and benefit levels for termination and severance packages are appropriate. The
staff is suggesting that companies also disclose the total amount the company is required to pay each NEO in the event of termination of the NEO or change of control of the company.
- Justifications for Withholding Performance Targets. The official report states that the issue of disclosure of performance target (which include elements of an executive’s individual performance targets
as well as elements of a company’s overall performance) as a component of executive compensation is the most commented area of the proxy disclosures. If a company determines that performance targets are a material element
of the company’s executive compensation policies and decision, or if the staff decides that performance targets were material to a company’s compensation determination, the staff has made it clear that it is no longer
acceptable for a company to omit its performance targets from its proxy statements by merely stating that the release of such information would result in competitive harm. The staff is requesting justification for the company’s
belief that such competitive harm is likely, which requires that the company meet the confidential treatment standard that it must meet if the company were making a confidential treatment request under SEC Rule 83. The SEC
will require a company to disclose its performance targets if this standard is not met. Further, a company meeting this standard must disclose the difficulty or likelihood that the company will achieve its undisclosed performance
targets.
- Benchmarking. If a company indicates that peer group information is used in determining compensation, the staff is requesting additional disclosure regarding how such peer group information is used to determine
each element of compensation, including the identity of the companies used to set the parameters, disclosure of which elements of actual compensation are affected by the peer group information, as well as disclosure of how actual
compensation payments compare with targeted peer group parameters and the reasons for any differences.
- Role of CEO and Other Executive Officers in Compensation Decisions. The staff is requesting companies to provide an explanation of the CEO’s role in the determination of the compensation of executive
officers.
- Role of Compensation Consultants in Compensation Decisions. The staff is requesting additional disclosure regarding instructions given by the company to a compensation consultant as well as disclosure of whether
the consultant performs any additional services for the company.
- Discretion. Where a company indicates that it has discretion in determining the level or form of an element of executive compensation, the staff is asking the company to disclose the nature and extent of the discretion. For example, where a company indicated that it had discretion to grant or increase an award or payout, the staff requested the company to disclose whether the discretion was used and discuss to what extent such discretion can be used to increase the award or payout.
PLAIN ENGLISH The official report and Mr. White’s speech emphasize that the new executive compensation disclosure rules are principles-based, requiring companies to disclose information that is material to a
company’s executive compensation policies and objectives. With this principles-based philosophy in mind, the SEC is suggesting that companies emphasize material information and de-emphasize less important information
and information not required to be disclosed.
The SEC is asking companies to present their disclosures with more precision and in a format and language that is understandable to the reader. A “clearer, more concise presentation of executive and director compensation”
is the goal. Staff comments regarding the manner of presentation include requests that companies adhere to plain English principles, and include suggestions that companies use more tabular and graphical discussions to aid readers
in digesting the overwhelming amount of information included in the disclosures.
The staff therefore is requesting that companies replace boilerplate discussions with a more individualized analysis of how the company arrived at its compensation decisions and that companies redraft language that the company lifted
directly from its compensation plan or employment agreement in a way that is more clear and understandable. The SEC is also requesting that companies be mindful of font size in its tables and footnotes.
NEXT YEAR'S EXECUTIVE COMPENSATION PROXY DISCLOSURE
The scope of the SEC’s official report is limited to a discussion of the SEC’s comments and observations in connection with its initial review of the 2007 executive compensation disclosures. However, as reflected
above, the SEC has discussed the type of information and analysis it is seeking to elicit and expects that the second round of executive compensation disclosures will be drafted consistent with the principles and themes discussed
in the report.
In Mr. White’s speech, he suggests companies address the following four points when drafting the next round of executive compensation proxy disclosures:
- What is material to my shareholders and to my investors as they examine the compensation of our executives and make their voting decisions for our board of directors and investment decisions with respect to our company?
- What are the material elements of individual executive and corporate performance that are considered in setting executive compensation?
- What is the relationship between the objectives of our compensation program and the different elements of compensation?
- What are the material factors that relate to our compensation decision-making process?
Mr. White also recommends that companies review the staff’s comment letters issued in connection with the staff’s initial review. The SEC has not yet made public these comment letters, but they are expected to be made public within 45 days after completion of the staff’s review of the filings.