Keith Higgins, Director of Corp Fin, hinted that he might be giving us a welcome gift in the future: a revision of Item 10 of Schedule 14A, the proxy statement – in my view, a component of the disclosure rules that has too long been ignored and requires serious rethinking and rationalizing. In a recent speech to the National Institute on Executive Compensation, Higgins discusses what’s in store for Corp Fin now that the SEC is near completion of its Dodd-Frank mandate. Of course, Corp Fin is currently working on the Disclosure Effectiveness Project, which focuses initially on Regs S-K and S-X, but after that, Higgins advises, the staff will then turn to the executive compensation and corporate governance information in the proxy statement. (And not a moment too soon.) Among the areas in the proxy statement that the staff will consider are these:
Item 10 of Schedule 14A
You’ll recall that, for a proxy statement, Item 10 is applicable when a compensation plan is submitted for shareholder approval. First, Higgins observes that the descriptions of the material features of executive compensation plans are, shall we say, kinda long. Is that really necessary, given that the plans are filed with the SEC and often included as part of the proxy statement? “Do our rules need to provide better guidance about the matters that a company should cover in its ‘brief’ description, or might that lead to a checklist approach?” he asks. Is the information provided too detailed for investors? Does it provide them the right information? Should the SEC mandate a “format that better summarizes the key features of the plan?…How should the electronic availability of the plan document itself factor into the disclosure the company is required to make of the features of the plan?”
Now for the best part — the New Plan Benefits table, which requires companies to provide a table of the benefits that will be received by or allocated to specified persons and groups under the plan or amendment, where those benefits are determinable. However, “as is often the case with discretionary plans, the benefits or amounts to be received are not determinable…” In that event, the table must include benefits or amounts that “’would have been received by or allocated to [the persons and groups in the table] for the last completed fiscal year if the plan had been in effect, if such benefits or amounts may be determined. . . .’ That language might lead one to conclude, for example, that for a plan amendment simply increasing the number of shares available under the plan the table should disclose the amounts that the specified persons and groups received in the prior year under that plan. But what if a plan is being newly adopted? How do you determine what would have been received or allocated? Should those situations produce different results? Is additional guidance necessary?” More importantly, he questions if the table, as currently constructed, might perhaps be well past its prime: “this table was part of our rules well before the current compensation tables that appear in the proxy statement. Are there revisions to this table we should be considering to capture the information that is important to investors, but also reduce duplicative disclosure?”
Item 10 also requires additional information for specific types of plans, some of which may likewise be archaic. Higgins remarks that one
“set of rules addresses requirements when a pension or retirement plan is being submitted for shareholder approval. I am quite confident I never encountered such a situation in the 30 years I practiced law, although surely at one time these plans must have been submitted to shareholders. Is this requirement outdated? In addition, if the shareholder action relates to a plan under which options, warrants, or rights are granted, or to a specific grant of these rights, Item 10 lists several additional requirements. Much of this detailed, line-item information is likely included in the company’s description of the material features of a plan or in the New Plan Benefits table, although there are some requirements that might not otherwise be included. For example, there is a requirement to state the federal income tax consequences of the issuance and exercise of options both to the recipient and to the company. This requirement is limited only to options — and does not include restricted stock, cash-only rights or other types of awards. If investors consider this information important in deciding how to vote on a plan, wouldn’t it make sense to expand this requirement beyond options to include all forms of equity compensation? But is the tax effect of equity compensation arrangements important information for investors?”
Another potentially obsolete aspect of Item 10 is the requirement to furnish the information required by Item 201(d) of Reg S-K, the table disclosing securities (both outstanding and available) under shareholder approved and non-approved plans. Higgins observes that this requirement was adopted in 2001 before the SRO listing requirements for shareholder approval of equity plans essentially “made non-approved equity plans a thing of the past. Has this table, which was first required at a time when non-shareholder approved plans were practically an epidemic, now outlived its usefulness? Are any features of this table important to investors?”
Finally, in response to litigation in connection with compensation plan approvals, some companies have been disclosing such items as how they arrived at the number of shares for which approval is sought, the company’s equity burn rate over the past several years and the length of time that the company believes the shares being approved will last. Higgins wonders whether these items should be required?
Regulation S-K Disclosure Requirements
While proxy disclosure has become more complete, at least judging by the page count, the question is whether it is as clear as it should be. Say on pay has triggered some improvement in the design and communication of executive pay packages, in Higgins’s view, as well as enhanced shareholder engagement. However, “investor surveys have also continued to indicate a general dissatisfaction with the clarity and readability of executive compensation disclosure. As the staff and the Commission work to finalize the remaining Dodd-Frank Act executive compensation rules, I think it makes sense to continue to assess the current rules and look for ways to improve them.”
CD&A requires companies to “explain all material elements” of executive comp. Item 402(b) of Reg S-K identifies seven mandatory topics and 15 other topics to be considered. Higgins stresses that these “22 items are not — and were not intended be — a checklist of items that must be included.” Rather, the disclosure requirement is principles-based, and items are to be addressed only if material. However, Higgins wonders whether the items have become a checklist that companies feel compelled to cover: if so, “[a]re the 22 ‘bases’ contributing to the complexity and general dissatisfaction with company compensation disclosure, rather than assisting companies with examples of information that may be material to their compensation objectives and policies?…Further, in light of the impacts of say on pay, what changes, if any, should we be considering? A few investor surveys have highlighted continued feedback from investors that the CD&A needs to be more than a compliance document that only lawyers would ‘enjoy’ reading. How do we create incentives for companies to tell their story in a clear and effective manner?” Do executive summaries convey the story more effectively?
Should the SEC also revisit the Summary Comp Table or any of the other comp tables? For example, there are timing issues in connection with earning of comp and when it is reflected in the SCT (i.e., the earning of equity versus non-equity incentive awards). “Is that a problem and, if so, is it a problem worth fixing?” Higgins asks, “Does this anomaly result in more discussion in the CD&A, adding bulk to the already substantial disclosure that is being provided? Should we re-consider the ‘performance year’ approach to reporting equity grants?”
With regard to the other tables, Higgins assumes that investors would likely view all of the information in the other tables as useful, but then remarks that that seems inconsistent with the results of a survey that found that 55% of institutional investors believe that the ideal length of a proxy is about 25 pages. (The survey also found that only 38% of investors “believe that corporate disclosure about executive compensation is clear and easy to understand.” See this PubCo post.) However, the average length of a proxy statement today is 60 to 80 pages: “Is there a way to preserve the information in the tables for the investors that are interested in the layered details, but also reduce the proxy statement disclosure to a more manageable length?” Higgins asks, “Should we, for example, consider leaving the Summary Compensation Table in the proxy statement but having some of the ‘layered’ tables included only in the company’s Form 10-K?” That idea was apparently considered, but not adopted, in 1995. Some of issues related to that concept are whether streamlined disclosure should be permitted every year, which tables should be required in the proxy statement, whether tables should be included only in an EDGAR appendix or on a company’s website, and whether it is even practicable to require that the tables be filed in the Form 10-K, which is typically filed well before the proxy statement.
Compensation Committee Report
Compensation committee reports used to include information similar to, but less extensive than, the current CD&A, but the requirement was changed to be comparable to the brief audit committee report in 2006, when the CD&A was invented. Now the SEC is considering expanding the audit committee report (see this PubCo post), raising the question of whether the SEC should “also be considering whether changes are appropriate to provide more insight into the information the compensation committee used and the factors it considered in evaluating the company’s executive compensation? Further, should we go back to the basics and consider the purpose that this report is serving and the value to investors in retaining this report?”
Form S-8 was substantially simplified in 1990. Higgins wonders what else might be done now? Should S-8s be made more comparable to a WKSI shelf, which allows the registration of unspecified amounts of securities and the payment of filing fees on a “pay-as-you-go” basis at the time of each takedown? The current system, Higgins opines, is probably easily navigated for employee plans that offer options or restricted stock, but does
“become more problematic for a tax-qualified plan, such as a 401(k), that has a company stock investment option, where it is not possible in advance to know how many shares will be offered and sold. Should we consider whether Form S-8 should provide issuers the option to pay-as-they-go? If so, how should this feature be structured to take into account that investment decisions by employees, rather than the company, determine how many shares are sold? Should the flexibility be limited just to WKSIs, or is this accommodation something that should be made more broadly available? If our rules were to accommodate such a feature, should companies have to re-file a new Form S-8 every three years, as WKSIs do, or perhaps some other appropriate interval?”
In addition, for almost 35 years, the SEC has required registration of separate interests in employee benefit plans where the plan offers a company stock fund as an alternative for investment. Should the same be required if the plan offers a self-directed brokerage account that might allow investment in employer securities:
“Although the staff has traditionally viewed employer involvement in establishing a 401(k) plan as being beyond ministerial activities, and therefore requiring registration, maybe it is time that we reexamine this analysis at least for 401(k) plans with self-directed brokerage accounts in which employer securities could be, but may never be, purchased? How do other regulatory restrictions under tax and ERISA rules that apply to 401(k) plans affect these self-directed brokerage accounts or plans generally? To be sure, having employees with significant concentrations of their retirement savings invested in employer securities can be a potential problem — and one that has turned very real in several instances. But is the problem a securities law problem? What does Securities Act registration offer that ERISA does not? Has the threat of Securities Act liability in fact provided meaningful employee-investor protection or has registration been largely a compliance exercise? The principal guidance on qualified plans is now 35 years old and in my view is probably worth taking a fresh look at.”