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: The Journal of the Business Law Society

SEC?s recent report on Executive Compensation Disclosure

By Yuan-Yi Fang

INTRODUCTION

On this October, the Securities and Exchange Commission published observations from its review of the executive compensation disclosures from 350 public companies that were filed during the latest proxy season.[1] This report is very important for both companies and public because it is the first SEC?s review for how well companies were adapting to the significant revisions to the executive compensation disclosure rules that took effect last year.[2]

BACKGROUND

The Securities and Exchange Commission?s new executive compensation disclosure rules took effective on November 7, 2006.[3] These rules have significantly changed the disclosure a public company.[4] Under these new rules, a public company need to provide information about how it compensates its most highly paid executive officers, including its executive officer, financial officer, and directors.[5] On December 22, 2006, the Commission further amended the disclosure requirements for executive compensation with respect of the method for a public company to disclose stock and option award compensation.[6]
These new executive compensation disclosure rules have received positive comments from the shareholder advocates and the compensation experts.[7] They believed, ?the SEC's disclosure rules today are far better than they were before the agency passed its new rules last July.?[8] Nevertheless, they urged, ?[t]he SEC should have gone further, requiring two types of summary compensation tables: One would reflect an executive's targeted pay for a year, including the total grant-date value of options given that year?And one would reflect what an executive actually pockets in cash in a given year, including the value of his salary, bonus, cashed-in options, perks and money paid toward his retirement plans, etc.?[9]

2007?S REPORT

The 2007 repost is the SEC? review on how well in the past proxy season companies were adapting to the first significant revisions to the executive compensation rules in 15 years.[10] Two principal themes emerge from the staff?s review in the report: First, a company should focus on how and why a company arrives at specific executive compensation decision and policy in the Compensation Discussion and Analysis; second, the manner of presentation that is critical to helps the reader understand a company?s disclosure should be better organized and presented for both the lay reader and the professional.[11]
In this report, the SEC?s staff also provided the following principal comments to companies in order to achieve more direct, specific, clear and understandable disclosure that will foster enhanced and more informative executive compensation disclosure:

Presentation
In the Report, the SEC provided its comment on the issue of the manner, the format and the clarity on the presentation aspect of the executive compensation disclosure.[12] As for the manner of the presentation, the SEC addressed that item 402 of Regulation S-K requires a company to provide clear, concise, and understandable disclosure of all compensation awarded to the named executive officers and directors.[13] The SEC suggested that companies could improve the manner of presentation for the compensation disclosure by making some item more prominent.[14] The SEC found that investor understanding of the company?s disclosure is improved when a company emphasizes the material information and de-emphasizes less important information.[15]
As for the format of presentation, the SEC encouraged companies to use charts, tables, and graphs to help investor to understand the compensation disclosure.[16] The SEC also suggested that the methods of presentation should be tailored to a particular company?s circumstance.[17] As for the issue of the clarity, the SEC emphasized the plain English principles under Exchange Act Section 13a-20 and 15d-20 where companies are required to follow when presenting their executive compensation disclosure in the mandatory reports.[18] The SEC believed that a careful drafting that consists with plain English principles could result in a shorter, more concise and effective discussion that complies with the rules.[19] The SEC suggested companies to replace a boilerplate disclosure with a clear and concise discussion of their own facts and circumstances.[20]

Compensation Discussion and Analysis
In the aspect of the Compensation Discussion and Analysis, the SEC?s report provides it comments in the following topics: compensation philosophies and decision mechanics, disclosure of performance targets, benchmark, change-in-control and termination arrangements and corporate governance.[21] First, as for the compensation philosophies and decision mechanics, the SEC asked companies ?to refocus their Compensation Discussion and Analysis presentations on the substance of their compensation decisions and to disclose how they analyzed information and why their analyses resulted in the compensation they paid.?[22] The SEC suggested that companies should explain how their analyses of relevant information resulted in the decisions they made rather than explain the decision-making process.[23] Moreover, the SEC also asked companies to explain how their decisions made with respect to one compensation element influenced other elements.[24]
Second, as for the disclosure of performance target, the SEC asked companies to clearly lay out the way in which performance achievement is measured and translated into the determination of compensation.[25] The SEC emphasized that companies have to consider the disclosure framework provided by Item 402 of Regulation S-K only when they determine that a performance target is material to their compensation policies and decisions.[26] Moreover, even when companies determine that a performance target is material to their compensation policies and decisions, they can be exempt from disclosure if companies can show that disclosure of such target could cause the competitive harm.[27]
Third, in the aspect of the benchmarks, the SEC requested companies to provide appropriate disclosure when companies retained discretion on how to use the comparative compensation information.[28] The SEC also asked companies to identify the name the peer companies which they compare themselves for purposes of compensation benchmarks.[29]
Fourth, in the aspect of the change-in-control and termination arrangements, the SEC asked companies to explain ?why they structure the material term and payment provisions in their change-in-control and termination agreements? and ?how potential payments benefits under these agreements may have influenced their decisions regarding other compensation elements.?[30]
Finally, in the aspect of the corporate governance, the SEC focused on the identity of compensation decision maker, including the role of the executive officers and the nature and the scope of involvement of compensation consultant in the decision-making process.[31]

OBSERVATION

One of the main trends of the SEC?s approach can be observed from this 2007?s Reports is that the SEC is looking for the executive compensation disclosure that is meaningful and is readable for both lay and expert investors. First of all, the 2007?s report showed that the SEC is focusing on the substance rather than just format on the compensation disclosure. The boilerplate type?s disclosure cannot satisfy the SEC new compensation disclosure rules. A company needs to curtail the information and material to fit its particular facts and circumstance in the context of the executive compensation disclosure in order to be a meaningful disclosure under the view of the SEC. Moreover, the SEC is looking for the compensation disclosure that can be readable for both lay reader and professional. A company needs to consider the view of lay reader when using the term and method to explain its executive compensation in its disclosure.
Companies will not disclose their executive compensation voluntarily and they will try to test the boundary of the mandatory scheme of the executive compensation disclosure rules.[32] Because the new rules just hit the road one year only, the SEC took into account thee learning curve necessary for the new rules and scaled back its comments accordingly.[33] However, the SEC should and will expect more thoughtful disclosure in the executive compensation with heighten expectations and requirements in 2008.

[1] See Staff Observations in the Review of Executive Compensation Disclosure, at http://www.sec.gov/divisions/corpfin/guidance/execcompdisclosure.htm; See "Speech by SEC Staff: Where?s the Analysis," at http://www.sec.gov/news/speech/2007/spch100907jww.htm.

[2] Id.

[3] Staff Observations in the Review of Executive Compensation Disclosure, supra note 1.

[4] Id.

[5] Id.

[6] Id.

[7] Jeanne Sahadi, Better reporting on executive pay? Yes, but?- An amendment to new SEC rules leaves some experts question its value to shareholder, CNNMoney.com, January 03, 2007, available at http://money.cnn.com/2007/01/03/news/companies/sec_execcomp_amendrules/index.htm.

[8] Id.

[9] Id.

[10] Bradley T. Kamlet, SEC publishes reports on executive compensation disclosure (Oct. 12, 2007), http://nixonpeabody.com/publications_detail3.asp?ID=2060.

[11] Staff Observations in the Review of Executive Compensation Disclosure supra note 1.

[12] Id.

[13] Id.

[14] Id.

[15] Id.

[16] Id.

[17] See Staff Observations in the Review of Executive Compensation Disclosure, at http://www.sec.gov/divisions/corpfin/guidance/execcompdisclosure.htm

[18] Id.

[19] Id.

[20] Id.

[21] Id.

[22] Id.

[23] See Staff Observations in the Review of Executive Compensation Disclosure, at http://www.sec.gov/divisions/corpfin/guidance/execcompdisclosure.htm

[24] Id.

[25] Id.

[26] Id.

[27] Id.

[28] Id.

[29] See Staff Observations in the Review of Executive Compensation Disclosure, at http://www.sec.gov/divisions/corpfin/guidance/execcompdisclosure.htm

[30] Id.

[31] Id.

[32] Norvald Instefjord, Martin Walker and Pascal Frantz, ?Disclosure of Executive Compensation Contracts: An Ecnonomic Analysis? (March 2007), available at: http://ssrn.com/abstract=986729.

[33] Speech by SEC Staff, supra note 1.

Full post as published by The Journal of the Business Law Society on November 22, 2007 (boomark / email).