On October 10, 2007, the SEC staff issued a report summarizing its observations after completing an initial review of the compensation and related disclosures of 350 public companies under the new executive compensation disclosure rules. The report, entitled “Staff Observations in the Review of Executive Compensation Disclosure,” or “SEC Report”, is available on the SEC’s website (www.sec.gov) and outlines the principal comments provided by the staff in its 350 comment letters. The SEC Report was also recently discussed by senior SEC staff members at the 2nd Annual Proxy Disclosure Conference: Tackling Your 2008 Compensation Disclosures, held on October 9, 2007 (the “Proxy Disclosure Conference”).

The SEC Report, as well as recent speeches given by senior officials of the SEC’s Division of Corporation Finance, make clear the staff ’s desire to see companies provide more analysis on how and why specific compensation awards and policies are established, and better organize, clarify and streamline the disclosures. Many of the comments issued by the staff were prospective in nature, applying to disclosures in future filings. SEC officials at the Proxy Disclosure Conference indicated that they essentially gave many companies a “pass” for the 2007 proxy season, but warned that they expect better disclosure in the future.

Compensation Discussion and Analysis

The keynote speech at the Proxy Disclosure Conference by John White, the Director of the SEC’s Division of Corporation Finance, heavily emphasized that more analysis is needed in the Compensation Discussion and Analysis (CD&A) section of the proxy statement. He noted that analysis was often missing in the disclosures relating to performance targets, benchmarks, differences in compensation among executives, and change-in-control arrangements. Mr. White reiterated that the CD&A disclosure should be principles based, and that the disclosure examples in the rules are not exclusive and only apply to the extent they are relevant and material.

The SEC Report stated that the staff asked a substantial number of companies to refocus their CD&A section to disclose how they analyzed information and why their analysis resulted in the compensation paid. The staff suggested that companies shorten the discussion of compensation philosophies and decision-making processes and provide a better explanation of how and why those philosophies resulted in the numbers presented in the tables and how its analysis of relevant information resulted in decisions. The staff sometimes suggested that some of the less analytical discussion from the CD&A be relocated to the narrative following the relevant tables or the footnotes to those tables.

Another senior staff official at the Proxy Disclosure Conference suggested that when the staff comments that something is missing from the disclosure and the company thinks that the disclosure has been made, it should rethink the language – that sometimes comments are a result of disclosures not being sufficiently clear. Staff members and other commentators urged companies to reassess their CD&A as a whole in light of SEC comments rather than limiting the changes to specific wording “fixes.”

The staff indicated that it issued more comments regarding performance targets than any other disclosure topic in its review. Both the SEC Report and Mr. White stated that it was often difficult to understand how companies used performance targets or considered qualitative individual performance to set compensation. The staff indicated that it is not asking companies to give objective or quantitative explanations where decisions are in fact subjective assessments – they are simply asking companies “to clearly lay out the way that qualitative inputs are ultimately translated into objective pay determinations.”

Where targets were omitted based on claims of competitive harm, the staff often asked companies to demonstrate how competitive harm could occur. The standard for omitting performance targets is the same relatively high standard that applies when requesting confidential treatment for required disclosures generally. SEC staff members suggested that companies be specific in their statements concerning potential competitive harm, such as stating that a competitor could use a particular number for a particular purpose as an example of how the harm could occur. Where a company believes that its competitive harm analysis should receive confidential treatment, it should consider submitting its explanation pursuant to SEC Rule 200.83, the general rule for requesting confidential treatment of disclosure. Staff Legal Bulletin No. 1 (Feb. 28, 1970), available on the SEC’s website, contains an analysis for such requests, which should be submitted in paper form to avoid public disclosure by electronic means. Where the target information is properly omitted, the staff often asked companies to discuss, in a meaningful way, how difficult it will be for the executive or how likely it will be for the company to achieve the omitted target. The staff also reminded companies that when a non-GAAP financial figure was presented as a performance target, disclosure of how the figure was calculated from the audited financial statements is required.

At the Proxy Disclosure Conference, one of the outside counsel commentators suggested that in light of the increased scrutiny being given to the compensation process, he expected a movement toward most, if not all, compensation committees reviewing summaries that give a tally of all compensation for each of the Named Executive Officers (NEOs), including severance arrangements. While it may or may not be a breach of a director’s fiduciary duty to determine compensation without the use of tally sheets, it does appear to be best practices to be informed of each NEO’s total compensation and to take that information into consideration when setting compensation amounts.

The SEC Report indicates that where a compensation committee analyzed “tally sheet” information, the staff asked for an explanation of what the tally sheet information was and how it impacted compensation decisions. The staff was also interested in the extent to which amounts paid or awarded under each element of compensation, and the amount of total compensation, affected the decisions made under other compensation elements. Mr. White commented in his speech that this would be an example of missing analysis.

Disclosure of compensation from prior years or actions taken in the current year may be required to give context to the disclosure provided or to present a fair understanding of the NEOs’ compensation for the last fiscal year. New or modified programs and policies or specific decisions made in the current year could be examples of this, as would situations where there is a multiple year plan or where performance target levels vary materially between years.

Where a company uses compensation information from other companies, and this benchmarking is material to its compensation decisions, it is required to identify the benchmark and, if applicable, its components, including the component companies.

The staff asked companies to provide more detail as to how they used comparative compensation information and how it affected compensation decisions. If a company retained discretion as to how to use benchmark information, it was asked to describe the nature and extent of that discretion and whether or how it exercised that discretion. The staff also gave comments requiring a significant number of companies to enhance their discussion of change-in-control and termination arrangements. They asked why the companies structured the material terms and payment provisions as they did and how potential payments and benefits under these arrangements may have influenced their decisions regarding other compensation elements.

Better Format and Clarity

The staff commented that the CD&A should be at the beginning of the compensation disclosure, putting into perspective the numbers in the tables. Approximately twothirds of the proxy statements reviewed included charts, tables and graphs that were not specifically required, and in almost all cases, the staff found the additional presentations to be helpful. A few companies included an alternative summary compensation table. Where this table was confusing or did not calculate items consistently with the rules, the staff asked that the alternative table be deemphasized and not presented more prominently than the required table. The staff also asked for an explanation of the differences between compensation amounts presented in the alternative versus the required tables. Some companies also voluntarily included a table containing potential payments upon termination or change-in-control. The staff generally supported this approach and suggested to several of these companies that they disclose the total amounts that would be required to pay their NEOs upon termination or change-in-control.

Mr. White’s speech also emphasized the importance of presentation, clarity and conciseness and pointed out that Chairman Cox is particularly focused on the importance of clear, concise and understandable disclosure.

Other Compensation Disclosures

The staff indicated that it did not detect any common theme in its review of the required named executive officer and director compensation tables, the footnotes to the tables or the narratives that followed them. Overall, they issued relatively few comments on this area of disclosure. With respect to compensation committee reports, there were a number of companies that did not include all of the information required, such as whether the committee reviewed and discussed the CD&A with management. These companies were asked to include this in future reports.

There were relatively few comments in the area of related person transactions. The staff did, however, ask a number of companies to provide a statement that their policies and procedures for review, approval, or ratification of related person transactions are in writing and, if not, to explain how they evidence such policies and procedures.

Finally, the staff commented in the area of corporate governance, primarily focusing on who was involved in making compensation decisions. Where the disclosure was unclear about who made the compensation decisions, the staff asked for clarification. Some companies were asked to more clearly describe the role of executive officers. Where consultants were used, some companies were asked to more specifically disclose the nature and scope of the consultant’s assignment and material instructions given by the company.

Conclusion

The SEC Report can be viewed as the SEC staff's attempt to notify all SEC reporting companies of the staff's most significant comments on the executive compensation disclosures this year. The staff has clearly signaled that it expects companies to have taken these comments seriously when they prepare their disclosures for future filings. To the extent the SEC Report's comments are applicable to their own disclosures, reporting companies would be well advised to make a good faith effort to address them, as well as to improve the format and presentation of their entire executive compensation disclosures, in their next proxy statement.