On October 9, 2007, the staff of the SEC’s Division of Corporation Finance issued a report summarizing its observations on the executive compensation disclosures filed during the 2007 proxy season. The report is based on the staff’s review of the disclosures of 350 public companies (primarily large ones) representing a broad range of industries. The staff’s comments generally are to be addressed by the recipients in supplemental submissions to the staff or in subsequent filings and therefore do not require revision of prior compensation disclosures. Like all staff comment letters, the comment letters and company responses will be posted on EDGAR 45 days after completion of a company’s review.
Although the review process is ongoing, the report summarizes the principal comments issued by the SEC staff in its initial review, and provides guidance on how companies can improve their compensation disclosures in the future. The report emphasizes two principal themes:
- The Compensation Discussion and Analysis (CD&A) must be more analytical by focusing on how and why the company arrives at specific compensation decisions and policies; and
- The manner of presentation should be designed to make the disclosures more meaningful and understandable, perhaps by employing techniques such as an executive summary and charts, graphs and tabular presentations tailored to the company’s executive compensation program.
The report is available at http://www.sec.gov/divisions/corpfin/guidance/execcompdisclosure.htm. Improving the Analysis in the CD&A
The SEC staff believes that companies generally furnished in the CD&A considerable detail on compensation mechanics and processes, but frequently did not provide sufficient analysis of how and why these processes resulted in the decisions made about compensation. Some methods of remedying this deficiency suggested by the staff include the following:
- Supplement any discussion of compensation philosophies with an explanation of how and why those philosophies resulted in the numbers presented in the required tables;
- Replace descriptions of the compensation decision-making process with a discussion of how the analysis of relevant information resulted in the decisions made;
- Explain the extent to which the amount of any compensation element affected the determination of the amount of any other compensation element;
- Where “tally sheet” information was used by compensation decision-makers, describe that information and explain how it affected compensation decisions;
- Discuss policies or decisions regarding each named executive officer individually, except where officers can be grouped together because the decisions regarding them were materially similar;
- Disclose performance targets that are material to the company’s policy and decisionmaking processes, or be prepared to demonstrate to the staff how disclosure of the particular targets could cause competitive harm;
- Identify any benchmarks that are material to the company’s policies and decisions and, if applicable, the components of the benchmarks (and as part of this disclosure identify component companies of any peer group used for comparison); and
- Explain why the material terms and payment provisions of change-in-control and termination arrangements were structured as they were, and how potential payments and benefits under these arrangements may have influenced decisions regarding other compensation elements.
In a speech given in connection with the release of the staff’s report (which is available at http://www.sec.gov/news/speech/2007/spch100907jww.htm), John White, the Director of the Division of Corporation Finance, emphasized that the lack of meaningful analysis in the CD&A was the biggest shortcoming in the filings reviewed. Mr. White suggested that, in the future, companies should consider beginning the process of drafting the CD&A by having each key participant in the process (from the compensation chair on down) prepare a one-page list of bullet-points addressing the “hows” and “whys” of the compensation-setting process. This list might include, as appropriate, the following matters:
- The key analytical tools used by the compensation committee;
- The findings that emerged from the analysis; and
- The resulting actions that affected executive compensation in the last year.
Mr. White suggested that the drafting team use these lists to draft the CD&A, working from a “clean slate,” or blank sheet of paper, rather than attempting to incorporate the information from the lists into the prior year’s CD&A.
Enhancing the Presentation of Compensation Information
The SEC staff’s report encourages companies to tailor the method of presentation to the company’s particular circumstances and to provide disclosure in plain English that is direct, clear, and concise. According to the report, approximately two-thirds of the companies reviewed used charts, tables, and graphs not required by the rules to supplement their compensation discussions. The staff also suggested the following guidelines for achieving greater clarity:
- Emphasize material information (such as how and why compensation levels were established) by featuring this information more prominently in the presentation, and deemphasize less important information (such as by shortening lengthy discussions of procedural aspects of the compensation program);
- Place the CD&A in front of the required compensation tables, because the CD&A is intended to provide a narrative overview that puts into perspective the numbers in the tables;
- Consider enhancing the discussion of termination or change-in-control payments by disclosing the total amount that would be payable upon each termination event;
- Avoid confusion when voluntarily presenting an alternative summary compensation table by ensuring that it is not presented more prominently than the required table and by explaining the differences between compensation amounts in the two tables;
- Replace boilerplate discussions with more specific analysis of the company’s own facts and circumstances (e.g., by replacing discussions of individual performance with more specific analysis of how the compensation committee considered and used individual performance to determine executive compensation); and
- Eliminate repetition in the narrative of information contained in the required tables, and substitute a clear and concise analysis of that information.
The SEC staff also discussed in its report a number of other items relating to the compensation disclosures.
Executive and Director Compensation Tables. The staff did not detect any common themes in its review of the required tables or related items and therefore issued few comments regarding them. Where a company appeared to make undisclosed assumptions in valuing option awards, the staff requested that the company either disclose the assumptions in a footnote to the applicable table or provide an appropriate cross-reference to the discussion of the assumptions elsewhere in the filing. The staff also noted that the Grants of Plan-Based Award table should list every planbased award made during the fiscal year and that the Outstanding Equity Awards at Fiscal Year- End table should include a footnote disclosing the vesting dates of all options, stock and equity incentive awards included in the table.
Compensation Committee Report. The staff advised several companies that their compensation committee reports did not include all required information (e.g., whether the compensation committee reviewed and discussed the CD&A with management).
Related-Person Transactions Disclosure. The staff advised a number of companies that they should indicate whether their policies and procedures for review, approval or ratification of relatedperson transactions are in writing and, if not, how they are evidenced.
Corporate Governance. The staff’s comments on corporate governance matters focused primarily on how compensation decisions were made. For example, the staff sought, where appropriate, clarification of who made compensation decisions, and a description of the role of any executive officer involved in the compensation decision-making process. In addition, the staff in some instances requested more specific information regarding the nature and scope of a consultant’s assignment and the material instructions given to the consultant.
The staff’s report and Mr. White’s speech make clear the staff’s view that there is considerable room for improvement in the disclosures made under the revamped executive compensation requirements put in place last year. This is hardly surprising, given the complexity of the new requirements and the lack of prior experience in applying them. Now that the staff has furnished more precise guidance, companies likely will be held to a higher standard of compliance in future years. Accordingly, companies should review their executive compensation policies and procedures in light of the recent guidance and revise them as appropriate