John White, Director of the Securities Exchange Commission (SEC) Division of Corporation Finance, recently summarized areas of SEC staff focus related to compensation disclosure.1 Mr. White also addressed the potential effect of the federal financial bailout bill, known as the Emergency Economic Stabilization Act of 2008, and economic conditions generally on CD&A disclosures.  

As discussed below, it is clear that the SEC staff expects reporting companies to improve CD&A disclosure, particularly in three areas:  

  1. The amount and quality of the analysis,
  2. The disclosure of performance targets, and
  3. “Benchmarking” or peer group reviews.  

In addition, SEC staff is focused on disclosure if current market or economic conditions have materially effected (or could materially effect) executive compensation decisions or program design. SEC disclosure rules require those factors to be discussed in a company’s CD&A.  

Areas of SEC Staff Focus


The SEC continues to believe that companies fall short in providing an analytical discussion of how they arrived at the levels of compensation for each named executive officer and why they believe their compensation practices and decisions fit within their overall objectives and philosophy. In his remarks, John White stated that the SEC staff continues to encourage companies to:  

  • Explain and place in context each of the specific factors considered when approving particular pieces of each named executive officer’s compensation package,
  • Analyze the reasons why the company believes that the amounts paid are appropriate in light of the various factors it considered in making specific compensation decisions, and
  • Describe why or how determination with respect to one element impacted other compensation decisions.  

Disclosure of Performance Targets

SEC rules require reporting companies to disclose in the CD&A the specific performance targets used to determine payouts under incentive compensation programs if the targets are material to the determination of the amounts paid under the plans. The rules permit companies to omit disclosure of the specific targets, and instead to provide only a narrative description of the performance measures used (e.g., total shareholder return or sales growth), if disclosure of the specific targets would result in “substantial competitive harm” to the company. If a company omits disclosure of specific targets under this exception, the company must describe the difficulty of achieving the target or explain how likely it is that the target will be achieved.  

The SEC staff is trying to limit reliance on the “competitive harm” exception and, when reviewing a proxy statement that omits disclosure of performance targets, typically asks for an in-depth analysis of the company’s industry and the competitive environment in which it operates, as well as specific examples of how performance targets could be used by a competitor to the company’s disadvantage. In addition, if the performance targets are not disclosed, the staff asks for more robust disclosure concerning the difficulty or likelihood of achieving the targets, including the factors considered by the compensation committee in setting the performance targets for the fiscal period (e.g., an historical analysis of the extent to which the targets were met in prior years and whether these historical results were a factor in the committee’s determination of the targets for the current period).  

“Benchmarking” and Peer Group Analysis

The CD&A must disclose whether a company engaged in benchmarking of total compensation or any element of compensation and, if so, identify the benchmark(s) and the component companies in the comparator or “peer” group. The SEC staff defines “benchmarking” as the use of compensation data about other companies as a reference point on which, either wholly or in part, to base, justify, or provide a framework for a compensation decision.  

If utilized, a company should be comfortable that its peer group is current and appropriate, and the CD&A should explain why the company believes the peer group is appropriate (e.g., based on industry, market cap, or revenues). Activist shareholders and senior SEC staff members have indicated that peer group selection should be reasonable and appropriate and that the selection criteria, including quantitative criteria such as revenue or market cap, if used, should be disclosed.  

Risk Analysis

The recently enacted Emergency Economic Stabilization Act of 2008, and the related Troubled Asset Relief Program (or TARP), impose certain limitations on the executive compensation paid by the financial institutions that choose to participate in the program. Among the limitations is a requirement that the institution ensure that the incentive compensation paid to senior executives does not encourage unnecessary or excessive risks that could threaten the value of the institution. Guidance from the Department of Treasury states that, to comply with the prohibition of “unnecessary and excessive risks,” the institution’s compensation committee must annually review the institution’s incentive compensation arrangements with the institution’s senior risk officers to ensure that the arrangements do not encourage the officers to take unnecessary and excessive risks. Further, the compensation committee must certify, in the institution’s CD&A, that it has completed the required review.  

In his remarks, John White suggested that the “unnecessary and excessive risks” limitation could have an impact on the disclosure obligations of companies that are not participating in the TARP program. White suggested that compensation committees, when creating incentives and establishing targets, should assess whether the incentives present a risk to the enterprise, and then should assess whether the risk analysis warrants disclosure in the CD&A. Specifically, White stated:  

“Would it be prudent for compensation committees, when establishing targets and creating incentives, not only to discuss how hard or how easy it is to meet the incentives, but also to consider the particular risks an executive might be incentivized to take to meet the target – with risk, in this case, being viewed in the context of the enterprise as a whole?”  

Current Economic Conditions

John White also reminded companies that the CD&A is required to discuss the material principles underlying a company’s executive compensation policies and decisions, and the most important factors relevant to analysis of those policies or decisions. White admonished companies to not simply “mark up” last year’s disclosure, but to carefully consider if and how recent economic and financial events have affected, or could affect, compensation decisions (e.g., end-of-year compensation decisions or modifications to currently existing executive compensation programs). For example, White stated the following:  

“…[h]ave you modified outstanding awards or plans, or implemented new ones? Have you reconsidered the structure of your program, or the relative weighting of various compensation elements? Have you waived any performance conditions, or set new ones using different standards? Have you changed your processes and procedures for determining executive and director pay…?”  

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As you begin to formulate the CD&A for the past year, please consider the foregoing.