The Securities and Exchange Commission recently reviewed the executive compensation disclosure of 350 companies under its new rules adopted in 2006. Following this review, the SEC issued comment letters to the companies reviewed and then issued a report that follows the general themes that run throughout these comment letters. Although the comment and response process is ongoing, the SEC has made no secret of what it will be targeting in future reviews. On the same day that the SEC released its report on executive compensation disclosure under the new rules, John White, Director of the SEC's Division of Corporation Finance, gave a speech asking "Where's the Analysis?" that reinforced the focus of the report. Companies looking ahead to next year’s disclosure should pay close attention to this guidance as they begin thinking about how to improve their disclosure for the upcoming annual reporting season.

This Update summarizes the key highlights from the SEC's report and John White's speech and provides practical guidance.

SEC Asks: Where's the Analysis?

The SEC and John White identified two principal themes to improve executive compensation disclosure.

• More and Better Analysis. The new Compensation Disclosure and Analysis section should clearly and concisely explain how and why a company makes its compensation decisions and policies.
  Clearer Presentation. Compensation disclosure should be presented in an understandable manner, using "plain English" principles, tabular presentation and better organization.

The interplay of improved analysis and clearer presentation results in more complete, accurate and comprehensible disclosure.

Write the Way Your English Teacher Taught You. In providing "clear, concise and understandable disclosure" under the new rules, companies must follow the "plain English" principles set forth in Rule 13a-20 and Rule 15d-20 of the Securities Exchange Act of 1934, which discourage use of legalistic jargon and syntax. In addition to being clear, disclosure must also be meaningful and responsive to the rules. To accomplish both objectives, companies should provide concise, analysis-driven disclosure, rather than lengthy discussion lacking depth. In addition, companies should avoid boilerplate language or repeating verbatim the text of provisions from agreements or plans, since that type of discussion rarely enhances the clarity or analysis. Companies should emphasize the more important elements of their executive compensation disclosure and deemphasize less important elements. Finally, despite the volume of information required in the tables, the tables and footnotes must be in a legible font size.

Stick to What's Material—Eliminate the Chaff. Because the CD&A disclosure is principles-based, companies must tailor the disclosure of material compensation policies and decisions to their particular facts and circumstances. What is material to an understanding of one company’s executive compensation may not be material for another company. Each company's CD&A should discuss, in a way that is tailored to that company's particular facts and circumstances, the material factors underlying the compensation that the company paid or awarded to its executives. Companies should work on developing analysis of the most material factors. Less important elements, like the procedural aspects of a company's stock plan or mechanics of decision-making, do not warrant as much explanation in the CD&A.

Explain How and Why Compensation Decisions Were Reached. Because the required tables already disclose compensation figures, companies should focus the CD&A on "how" they arrived at the particular levels and forms of compensation they paid and "why" they paid that compensation. The SEC believes companies will improve analysis by explaining how they applied compensation philosophies and decision-making processes to reach their compensation decisions, rather than just reciting what those philosophies and processes are. This analysis should reveal how compensation elements fit together. For instance, did the payment of one element of compensation affect the decision to pay another element? Where the compensation philosophies and decision-making processes differ by individual or group, companies should discuss the individuals or groups separately.

Disclose Material Performance Targets. Discussion of performance targets elicited the most comments from the SEC. Many companies stated that they used corporate or individual performance targets to determine whether to pay components of compensation, but did not disclose those targets. Under the new rules, if performance targets are material to understanding a company’s executive compensation, the company must disclose the targets, unless it can demonstrate that doing so would cause competitive harm based on the standards used in evaluating confidential treatment requests. If a company omits the targets based on a competitive harm analysis, the company must discuss how difficult it will be for the executive, or how likely it will be for the company, to achieve the undisclosed target levels. If the targets themselves are not material, then companies should not be discussing them in the CD&A.

Include More Benchmarking Analysis Detail. Companies that compared, or benchmarked, their executive compensation to a peer group must disclose, if material, the benchmark, the companies that make up the peer group and any relevant components of compensation used in the benchmark. Companies should also discuss how they used the benchmarking information to reach their compensation decisions. If companies had discretion in how they used the benchmarking information, they should explain the extent of the discretion and whether they exercised the discretion.

Change-in-Control and Post-Termination Payments: Why Are They Structured the Way They Are? Companies should discuss change-in-control and post-termination payments in the context of other elements of executive compensation. The discussion should cover how the various compensation elements fit together and advance the company’s compensation objectives and whether the existence of these potential payments affects the company’s decisions as to other elements of compensation.

Additional Information

This update is only intended to provide a general summary of the SEC guidance. You can read the full text of the SEC's report at http://www.sec.gov/divisions/corpfin/guidance/execcompdisclosure.htm. You can read the full text of John White's "Where's the Analysis?" speech at http://www.sec.gov/news/speech/2007/spch100907jww.htm. You can find discussions of other recent cases, laws, regulations and rule proposals of interest on our website.

In this update we have used the style and format for "Practical Tips" from The Public Company Handbook: A Corporate Governance and Disclosure Guide for Directors and Executives (Bowne SecuritiesConnect(TM) Library). The third edition of The Public Company Handbook may be ordered by email to SecuritiesConnect@bowne.com.