SEC Review of Executive Compensation Disclosures

PDF version   In 2006, the Securities and Exchange Commission (SEC) adopted broad reforms to the disclosure rules regarding executive compensation. The new rules resulted in significant changes in the manner in which public companies prepared and presented executive compensation disclosure information in their proxies and 10-Ks.

Among other things, the new rules increased the number of tables and level of quantitative detail that must be included in compensation disclosure, and also created a significant new area of largely qualitative disclosure regarding executive compensation, known as the Compensation Discussion and Analysis, or CD&A. The new requirements became effective for most companies beginning in the 2007 proxy season concluded in the spring of this year.

While many companies spent a great deal of time and effort in working to comply with the novel and complex rules, and in particular in drafting the CD&A, reactions to the overall quality of the new disclosure have been mixed, with general comments and criticisms coming from the business media, shareholder and corporate groups, and members of the SEC staff.

Recently, individual companies have begun to receive specific feedback from the SEC staff on their disclosures. In mid to late August 2007, approximately 300 comment letters, each generally containing between 10 to 15 comments, were issued, and then in late September 2007, the staff sent additional comment letters. In the next phase of its special project, on October 9, 2007, the SEC issued a report summarizing its findings and issuing guidance for the 2008 proxy season.

Companies receiving individual comment letters should be and presumably are consulting with counsel and working internally in order to respond to the comments and alter their disclosure as necessary for future filings. Importantly, however, companies that have not received comments should also be considering, and consulting with their counsel in doing so, how the matters addressed in the staff’s comments and in the SEC’s October 9 report will affect their own reporting.

The SEC’s Feedback

The October 9 report identifies two principal themes as having emerged from the staff’s review of compensation disclosure. First, the SEC staff comments that “the CD&A needs to be focused on how and why a company arrives at specific executive compensation decisions and policies.” Second, it states that “the manner of presentation matters—in particular, using plain English and organizing tabular and graphical information in a way that helps the reader understand a company’s disclosure.”

The report also discusses the general categories into which most of the staff’s company-specific comments have fallen, which we have also observed in our review of a number of comment letters. These areas include:

• CD&A in general. There is a general emphasis on encouraging companies to provide clearer and more analytical disclosure of compensation policies and decisions in their CD&A, with a reduced focus on the mechanics of the compensatory plans and arrangements. There is also fairly consistent criticism of the length and technical complexity of CD&A—the staff would prefer to see CD&As that are “shorter, crisper and clearer.”
   
• Compensation philosophies and decision mechanics. The staff would like to see more detailed discussion on how and why compensation philosophies, which many companies discussed only in a conceptual manner, “resulted in the numbers presented in the required tables.”
   
• Differences in compensation policies and decisions. Where a company’s compensation policies are materially different for individual named executive officers, those differences should be addressed. Most of the comments we reviewed in this vein were focused on CEO compensation.
   
• Performance targets. This was the most prevalent subject of staff comments and will likely be the subject of much concern as the 2008 proxy season approaches. The staff clearly expects to see disclosure of the specific company and individual performance targets established with respect to executive compensation that are material to these compensation arrangements, and the ways in which those targets are adjusted or refined in the context of individual compensation decisions. Where companies feel that they may face competitive harm by disclosing such targets, they will be required to demonstrate why; this is likely to be a difficult standard to satisfy.
   
• Benchmarks. The staff seeks more detailed disclosure of how comparative compensation information was used and, when peer groups are used in benchmarking analysis, identification of the peers taken into account.
   
• Change-in-control and termination arrangements. In this context, the staff will require more discussion of how the various elements of these arrangements were determined, how such determinations fit into a company’s overall compensation philosophy, and how they affected other compensation decisions. The staff also felt that tabular disclosure of the various amounts payable under these arrangements was very helpful to shareholders and encouraged the use of such tables, with a total payment column at the end.

In addition to these more prevalent comments, other common comments related to:

• The executive and director compensation tables
• Compensation committee report
• Related person transaction disclosure
• Corporate governance issues
   

Planning Ahead

The staff’s comments and recent report raise a number of concerns that will certainly need to be factored into every reporting company’s executive compensation disclosure in future filings, regardless of whether the company itself has received comments. Individual compensation committees, along with company management, should begin now to evaluate how the staff’s more general comments, and the themes expressed in the October 9 report, would apply to the company’s own disclosure, and how the disclosure can be altered and improved in future filings. Individual compensation committees should also consider whether, in light of the altered disclosure landscape that will result from the implementation of many of the staff’s directives, they might want to revise any of their compensation practices. Importantly in this regard, companies should carefully consider how performance targets are analyzed and established, as it seems likely that many companies will not only have to disclose performance targets but also the process for setting them.

The 2008 proxy season will again be an interesting time for reporting companies and their compensation committees, consultants, and advisors. We at Morgan Lewis are here to help you through this process. If you have any questions or would like additional information concerning the issues raised in this Morgan Lewis LawFlash, please contact one of the following attorneys:

New York
Stephen P. Farrell

Princeton
Andrew P. Gilbert
Emilio Ragosa

Philadelphia
Justin W. Chairman