It has been just over a year since the SEC promulgated its new executive compensation disclosure requirements. The new rules resulted in a substantial change in executive compensation disclosure and were the most substantial revision to the executive compensation disclosure rules since 1992. As is often the case with complex rulemaking initiatives, over the past year, the SEC has issued additional guidance, both formally and informally, to assist registrants in preparing their annual executive compensation disclosure. Most recently, on Oct. 9, 2007, the SEC's Division of Corporation Finance published its "Staff Observations in the Review of Executive Compensation Disclosure."
The Staff Observations are an overview of the staff's review of the executive compensation disclosures under the 2006 rules of 350 public companies across a broad range of industries. This large-sample review was intended both to gauge compliance with the new executive compensation disclosure rules and to provide guidance to the approximately 16,000 other public registrants as they prepare their executive compensation disclosure for 2008.
The Staff Observations address both the presentation and substance of executive compensation disclosure. In particular, the staff's comments focus on two broad themes:
- the need for more analysis in the Compensation Discussion & Analysis, or CD&A, of "how" and "why" registrants arrived at specific executive compensation decisions and policies; and
- presentation improvements to improve the clarity and readability of the disclosure.
The Staff Observations include reminders of mandatory requirements contained in the executive compensation disclosure rules, as well as suggested best practices. The highlights of the Staff Observations are summarized below.
Presentation of Information
- Consider the use of an executive summary to make the disclosure more useful and meaningful.
- Make material information more prominent in the disclosure and de-emphasize less important information. For example, registrants should emphasize in the CD&A how and why they established compensation levels and de-emphasize and shorten lengthy discussions of compensation program mechanics.
- Place required compensation tables after the CD&A. The CD&A is intended to be a narrative overview at the beginning of the executive compensation disclosure, putting into perspective the tables that follow it.
- Consider using additional tables to enhance disclosure. According to the staff, approximately twothirds of the registrants reviewed included charts, tables and graphs not specifically required by the revised rules.
- Compensation, related person, beneficial ownership and corporate governance disclosures must be in plain English.
- Registrants should avoid boilerplate disclosure. Where the staff found that a registrant presented boilerplate disclosure, it asked the registrant to provide a clear and concise discussion of its own facts and circumstances. For example, in the comment process, the staff asked a significant number of registrants to replace boilerplate discussions of individual performance with more specific analysis of how the compensation committee considered and used individual performance to determine executive compensation.
- The narrative disclosure should not merely repeat information contained in the required tables. The registrant should either replace the disclosure with a clear and concise analysis of the information in the tables or relocate the discussion to the narrative following the appropriate tables or to the footnotes to those tables.
- Be mindful of font sizes in tables and related footnotes. Where practicable, increase font size to enhance readability.
- Disclosure of compensation plans and employment agreements should be presented in a clear and understandable manner. It generally should not be identical to the language in the plan or agreement.
Analysis of Compensation Policies and Decisions Generally
As indicated above, a general theme in the Staff Observations was the sufficiency of the analysis of "how" and "why" certain executive compensation decisions were made.
- The staff indicated that many registrants discussed their compensation philosophies and decision mechanics in great detail. The staff asked a substantial number of registrants to refocus the CD&A presentation on the substance of their compensation decisions and to disclose how the registrant analyzed information and why the analysis resulted in the compensation paid.
- Registrants should discuss the extent to which the amounts paid or awarded under each compensation element affected the decisions made regarding amounts paid or awarded under other compensation elements. They should place in context how and why the determinations made with regard to one compensation element may or may not have influenced decisions made with respect to other compensation elements contemplated or awarded.
- Where the compensation policies and decisions for individual named executive officers are materially different, the individuals should be discussed separately in the CD&A.
In its review, the staff issued more comments regarding performance targets than any other disclosure topic. The 2006 executive compensation disclosure rules provide 15 examples of items that may be material elements of a registrant's compensation policies and decisions. One of these items is the registrant's use of corporate and individual performance targets. In its review process, the staff noted that a substantial number of registrants either alluded to using, or disclosed that they used, corporate and individual performance targets to set compensation policies and make compensation decisions. Corporate performance targets ranged from financial targets, such as earnings per share, EBITDA and growth in net sales, to operational or strategic goals, such as increases in market share or targets specific to a particular division or business unit.
- According to the staff, most registrants reviewed disclosed that their compensation committees considered individual performance in making executive compensation decisions, although few disclosed how they analyzed individual performance or whether they focused on specific individual performance goals as part of that analysis. The CD&A should indicate how the registrant used performance targets or considered qualitative individual performance to set compensation policies and make compensation decisions. Where performance targets are material to a registrant's policy and decision-making processes, it should disclose those targets unless it can demonstrate that disclosure of particular targets could cause it competitive harm. If the targets are not disclosed, registrants are required to discuss how difficult it will be for the executive or how likely it will be for the registrant to achieve undisclosed target levels.
- If a non-GAAP financial figure is presented as a performance target, the registrant must disclose how it would calculate that figure.
- The CD&A should cover actions regarding executive compensation taken after the end of the fiscal year covered by the periodic report. A registrant also should consider whether it needs to disclose prior year performance targets and whether they were achieved to place disclosure for the year covered by the periodic report in context or to provide the reader with a fair understanding of a named executive's compensation.
Many registrants use compensation information from other companies to determine their own compensation levels. A number of the staff's comments centered around benchmarking.
- In a substantial number of comments, the staff asked registrants to provide a more detailed explanation of how they used comparative compensation information and how that comparison affected compensation decisions.
- If the registrant retains discretion to benchmark to a different point or range or to not benchmark at all, it should disclose the nature and extent of the discretion and how it exercised that discretion.
- If the registrant benchmarks compensation to its peers, it should identify the companies to which it compares itself as well as the compensation components used in that comparison.
- The registrant should indicate where its compensation fell within the benchmarked range.
Change of Control and Termination Arrangements
- In a number of comment letters, the staff asked registrants to disclose why they structured the material terms and payment provisions in their change of control and termination arrangements as they did.
- The staff also asked registrants to discuss how potential payments and benefits under these arrangements may have influenced their decision regarding other compensation elements.
Compensation Committee Report
- Registrants should confirm that the compensation committee report meets the technical requirements of the executive compensation rules. The staff indicated that a number of registrants furnished compensation committee reports that did not include all of the information required by the rules. For example, some registrants did not indicate whether the compensation committee reviewed and discussed the CD&A with management.
Related Party Transactions
- Registrants should indicate whether policies for the review, approval or ratification of related person transactions are in writing and, if not, they should explain how they evidence their policies and procedures.
The staff's comments on corporate governance focused primarily on who was involved in making compensation decisions.
- Disclosure should clearly indicate who makes compensation decisions.
- Where a registrant indicates that its principal executive officer has a role in the compensation decision-making process, the disclosure should describe his or her role.
- The disclosure should disclose with specificity the nature and scope of any compensation consultant's assignment and the material instructions given to it by the registrant.