Staff Observations in the Review of Executive Compensation Disclosure
Division of Corporation Finance
The Division of Corporation Finance has completed its initial review of the executive compensation and related disclosure of 350 public companies under the Securities and Exchange Commission’s new and revised rules relating to executive compensation disclosure. Two principal themes emerge from our reviews and our individualized comments to these companies.
First, the Compensation Discussion and Analysis needs to be focused on how and why a company arrives at specific executive compensation decisions and policies. This does not mean that disclosure needs to be longer or more technical; indeed shorter, crisper, and clearer would often be better. The focus should be on helping the reader understand the basis and the context for granting different types and amounts of executive compensation.
Second, the manner of presentation matters — in particular, using plain English and organizing tabular and graphical information in a way that helps the reader understand a company’s disclosure. The executive compensation rules require companies to disclose a great deal of information. Techniques such as providing an executive summary, or creating tables or charts tailored to a company’s particular executive compensation program, can make the disclosure more useful and meaningful. We encourage companies to continue thinking about how executive compensation information — from the big picture to the details — can be better organized and presented for both the lay reader and the professional.
The Securities and Exchange Commission’s new and revised rules relating to executive compensation disclosure became effective on November 7, 2006. These rules have significantly changed the disclosure a public company provides about how it compensates its most highly paid executive officers, including its principal executive officer and its principal financial officer, and its directors. On December 22, 2006, the Commission further amended the disclosure requirements for executive and director compensation with respect to how a public company discloses stock and option award compensation. The revised rules also update and clarify the related person transaction disclosure requirements and consolidate and add corporate governance disclosure requirements.
In the Division of Corporation Finance’s regular review of public company current and periodic reports, we routinely provide comments to companies in which we seek clarification of current disclosure or additional information so we may better understand why a company made a particular disclosure. In some instances, we may ask a company to revise or enhance its disclosure by amending the document in which it has provided it. In other instances, we may ask a company to revise or enhance its disclosure in future filings.
In 2007, we undertook a project to review the executive compensation and other related disclosure of 350 public companies to evaluate compliance with the revised rules and provide guidance on how those companies could improve their disclosure. In identifying 350 companies for review, we sought to cover a broad range of industries. No one should interpret our selection of any company for review as part of this project as any indication of our views regarding the quality of that company’s disclosure.
We have provided comments to companies based on a company’s individual facts and circumstances and the nature and extent of its disclosure. Our goal in providing comments to companies is to assist them in enhancing the overall disclosure in their filings. These reviews are ongoing. Not less than 45 days after we complete our review of a company’s filing, we will post the correspondence containing our comments and company responses to our comments on the SEC’s EDGAR system.
In this report, we discuss the principal comments we provided to companies. Because our reviews are ongoing, our discussion is limited to our initial comments and does not reflect how companies may propose to revise their disclosure in response to them. We encourage companies to review their disclosure and prepare future disclosure consistent with the principles and themes of our comments. In our comments, we seek, where applicable, more direct, specific, clear and understandable disclosure. We believe this will foster enhanced and more informative executive compensation disclosure.
Manner of Presentation
Item 402 of Regulation S-K requires a company to provide “clear, concise, and understandable disclosure of all plan and non-plan compensation awarded to, earned by, or paid to the named executive officers . . . and directors . . . by any person for all services, rendered in all capacities . . . .”
In a number of instances, we suggested ways we thought companies could improve the manner in which they presented their executive compensation disclosure. For example, in a significant percentage of the filings we reviewed, we suggested that companies should consider making some items of their disclosure more prominent. Throughout our long history of reviewing company disclosure, we have often found that where a company emphasizes material information and de-emphasizes less important information, investor understanding of the company’s disclosure is improved. As another example of our comments in this area, we suggested that companies could improve their presentation by emphasizing in their Compensation Discussion and Analysis how and why they established compensation levels, and de-emphasizing and shortening lengthy discussions of compensation program mechanics.
For the most part, we found the format of executive compensation and other related disclosure to be relatively consistent across the 350 company filings. We commented on the format or manner of presentation where we found it adversely affected the overall readability of the company’s disclosure. In adopting the revised rules, the Commission stated that the Compensation Discussion and Analysis is meant to be a narrative overview at the beginning of the compensation disclosure, putting into perspective the numbers in the tables that follow it. Where a company placed its required compensation tables before the Compensation Discussion and Analysis, we asked it to relocate those tables so that they would follow the Compensation Discussion and Analysis.
Approximately two-thirds of the companies we reviewed included charts, tables and graphs not specifically required by the revised rules. In almost every instance, we found these additional presentations to be helpful. For example, we found that a number of companies voluntarily included a table in which they presented information regarding potential payments upon termination or change-in-control. To enhance investor understanding of these tables, we suggested to some companies that they disclose the total amounts they would be required to pay their named executive officers upon termination or a change-in-control.
We encourage methods of presentation that are tailored to a particular company’s circumstances, which we believe can be useful to investor understanding. Of the 350 companies we reviewed, a few companies included alternative summary compensation tables. Where a company presented an alternative summary compensation table that we found to be confusing or one which included compensation amounts calculated in a manner inconsistent with the revised rules, we asked the company to de-emphasize the alternative table and ensure that it was not presented more prominently than the required table. To the extent that a company’s discussion or presentation of an alternative summary compensation table did not overshadow or detract from the required tables, we generally did not comment. Where the title of an alternative summary compensation table could lead a reader to assume that the alternative table was part of the required compensation tables, we asked the company to change the title. Where necessary, we asked companies to state that an alternative summary compensation table is not a substitute for the information the revised rules require. Finally, we asked those companies that presented alternative summary compensation tables to explain differences between compensation amounts presented in those tables and compensation amounts presented in the required tables.
When the Commission adopted the revised rules it affirmed its support of plain English principles by stating that “[c]learer, more concise presentation of executive and director compensation, related person transactions, beneficial ownership and corporate governance matters can facilitate more informed investing and voting decisions in the face of complex information about these important areas.” Companies are required to follow the drafting principles presented in Exchange Act Rules 13a-20 and 15d-20 when presenting their executive and director compensation, related person transactions, beneficial ownership and corporate governance disclosures in reports they are required to file under Exchange Act Section 13(a) or 15(d). These rules contain the plain English requirements.
It is important to recognize that disclosure can be clear and understandable yet not meaningful or responsive to disclosure requirements. Conversely, disclosure can be responsive in content, but not clear and understandable. As we discuss below, we found that, in several instances, companies made a good faith effort to provide clear and understandable disclosure, but fell short of full compliance with the underlying disclosure requirements. For example, we found that a significant number of companies could improve their analyses of how and why they made certain executive compensation decisions. Where we ask a company to add analysis, or enhance its analysis, we do not necessarily think that it should lengthen its disclosure. Rather, careful drafting consistent with plain English principles could result in a shorter, more concise and effective discussion that complies with our rules.
In adopting the revised rules, the Commission stated that “[t]he purpose of the Compensation Discussion and Analysis disclosure is to provide material information about the compensation objectives and policies for named executive officers without resorting to boilerplate disclosure.” Where we found that a company presented boilerplate disclosure, we asked it to provide a clear and concise discussion of its own facts and circumstances. For example, we asked a significant number of companies 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. Where a company repeated information from the required compensation tables, we asked it to replace that disclosure with a clear and concise analysis of the information in the required compensation tables or to relocate the discussion to the narrative following the appropriate tables or the footnotes to those tables. Where a company’s disclosure appeared identical to language in a compensation plan or employment agreement, we asked it to present the information in a clear and understandable manner.
Although we recognize that several of the required tables require companies to present a number of columns, we asked some companies to be mindful of font size in their tables and related footnote presentations and to increase, where practicable, font size to enhance readability.
Compensation Discussion and Analysis
When the Commission adopted the revised rules, it stated that they “are intended to provide investors with a clearer and more complete picture of compensation to principal executive officers, principal financial officers, the other highest paid executive officers and directors.” To bring this picture into focus, the Commission adopted a new principles-based requirement for a company to provide material information about compensation objectives and policies for its named executive officers, the Compensation Discussion and Analysis.
In adopting the Compensation Discussion and Analysis, the Commission presented a disclosure concept and provided both principles and examples to help companies identify disclosure applicable to their own facts and circumstances. The Commission expressly stated that the Compensation Discussion and Analysis “strikes an appropriate balance that will effectively elicit meaningful disclosure, even as new compensation vehicles develop over time.” The principles-based disclosure concept allows each company to assess its own facts and circumstances and determine what elements of the company’s compensation policies and decisions are material and warrant disclosure.
The Commission explained that the primary focus of the Compensation Discussion and Analysis should be “[m]uch like the overview that we have encouraged companies to provide with their Management’s Discussion and Analysis of Financial Condition and Results of Operations. . . .” The Commission stated that “the new Compensation Discussion and Analysis calls for a discussion and analysis of the material factors underlying compensation policies and decisions reflected in the data presented in the tables.” Further, the Commission advised companies that “the Compensation Discussion and Analysis requirement is principles-based, in that it identifies the disclosure concept and provides several illustrative examples.” The Commission also made clear that, in addition to discussing its compensation policies and decisions, a company responding to the principles-based disclosure requirement must analyze the material factors underlying those policies and decisions.
In many of our comment letters, we asked companies to enhance their analyses of compensation policies and discussions, including how they determined the amounts of specific compensation elements. In providing these comments to companies, our goal is to help companies enhance their discussions of how they arrived at the particular levels and forms of compensation that they chose to award to their named executive officers and why they pay that compensation, giving investors an analysis of the results of their compensation decisions. We discuss a number of these comment areas below.
Compensation philosophies and decision mechanics
We found that a number of companies discussed their compensation philosophies and decision mechanics in great detail. We asked a substantial number of 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. For example, where a company provided a lengthy discussion about its compensation philosophies, we suggested that it improve its Compensation Discussion and Analysis by explaining how and why those philosophies resulted in the numbers they presented in the required tables. Similarly, where a company provided a lengthy discussion about its decision-making process, we suggested that, rather than explaining the process, it explain how its analysis of relevant information resulted in the decisions it made.
We asked a significant number of companies to discuss the extent to which the amounts paid or awarded under each compensation element affected the decisions they made regarding amounts they paid or awarded under other compensation elements. Consistent with Item 402(b)(1)(vi), we asked these companies to place in context how and why the determinations they made with regard to one compensation element may or may not have influenced decisions they made with respect to other compensation elements they contemplated or awarded. Where a company disclosed that its compensation committee analyzed “tally sheet” information, for example, we asked the company to explain what “tally sheet” information was and discuss how it impacted the committee’s decision on compensation awards.
Differences in compensation policies and decisions
Item 402(b) requires companies to discuss their compensation policies and their decisions regarding compensation of their named executive officers. When adopting this requirement, the Commission stated that “[t]he Compensation Discussion and Analysis should be sufficiently precise to identify material differences in compensation policies and decisions for individual named executive officers where appropriate. Where policies or decisions are materially similar, officers can be grouped together. Where, however, the policy or decisions for a named executive officer are materially different, for example in the case of a principal executive officer, his or her compensation should be discussed separately.” Where a company’s disclosure, including that in the Summary Compensation Table, led us to believe that its policies and decisions for individual named executive officers may be materially different, we reminded the company of the Commission’s statement.
Item 402(b)(2) provides fifteen examples of items that may be material elements of a company’s compensation policies and decisions. Among the elements of a company’s compensation policies and decisions that may be material and warrant disclosure is the company’s use of corporate and individual performance targets. Evaluating whether corporate and individual performance targets warrant disclosure is not a new concept for public companies in preparing their executive compensation disclosure. Prior to 2006, the Commission’s executive compensation disclosure rules required a company’s compensation committee to describe each measure of company performance on which it based the Chief Executive Officer’s compensation. Companies were not required to disclose target levels involving confidential commercial or business information where disclosure would have had an adverse effect on the company.
In adopting the revised rules, the Commission carefully considered public company disclosure practices and the differing views of a wide variety of commenters. Rather than presenting a specific requirement to disclose corporate and individual performance targets, the Commission adopted a principles-based disclosure model in which a company determines whether performance targets are a material element of its compensation policies and decisions. If a company determines they are material, Item 402 provides the disclosure framework for the company to follow.
We found that a substantial number of companies alluded to using, or disclosed that they used, corporate and individual performance targets to set compensation policies and make compensation decisions. We found that 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. Most companies we reviewed disclosed that their compensation committees considered individual performance in making executive compensation decisions, although few companies disclosed how they analyzed individual performance or whether they focused on specific individual performance goals as part of that analysis.
We issued more comments regarding performance targets than any other disclosure topic in our review of the executive compensation and other related disclosure of the 350 companies. We often found it difficult to understand how companies used these performance targets or considered qualitative individual performance to set compensation policies and make compensation decisions. In making these comments, we do not seek to require companies to defend what may properly be subjective assessments in terms of purely objective or quantitative criteria, but rather only to clearly lay out the way that qualitative inputs are ultimately translated into objective pay determinations.
Where it appeared that performance targets were material to a company’s policy and decision-making processes and the company did not disclose those targets, we asked it to disclose the targets or demonstrate to us that disclosure of the particular targets could cause it competitive harm.1 We reminded companies of Instruction 4 to Item 402(b) which requires them to discuss how difficult it will be for the executive or how likely it will be for the company to achieve undisclosed target levels or other factors. Where a company omitted a performance target amount but discussed how difficult or likely it would be for the company or individual to achieve that target, we often sought more specific disclosure that would enhance investor understanding of the difficulty or likelihood.
Where a company presented a non-GAAP financial figure as a performance target and the company did not disclose how it would calculate that figure, consistent with Instruction 5 to Item 402(b)(2), we asked it to disclose how it would do so. For example, where a company disclosed total shareholder return as a performance target, we asked the company to disclose how it would calculate total shareholder return and describe how it would influence compensation decisions.
In adopting the revised rules and addressing commenters’ requests for clarification about whether the Compensation Discussion and Analysis is limited to compensation for the last fiscal year or should also address prior or current year matters, the Commission stated:
While the Compensation Discussion and Analysis may also require discussion of post-termination compensation arrangements, on-going compensation arrangements, and policies that the company will apply on a going-forward basis, Compensation Discussion and Analysis should also cover actions regarding executive compensation that were taken after the last fiscal year’s end. Actions that should be addressed might include, as examples only, the adoption or implementation of new or modified programs and policies or specific decisions that were made or steps that were taken that could affect a fair understanding of the named executive officer’s compensation for the last fiscal year. Moreover, in some situations it may be necessary to discuss prior years in order to give context to the disclosure provided.
While disclosure will always depend upon each company’s particular facts and circumstances, there are a number of situations where a company may find it necessary to discuss prior and current year performance targets to place its disclosure in context or affect a fair understanding of a named executive officer’s compensation. It also may be material for a company to disclose whether the company or the named executive officer achieved or failed to achieve targets in prior years. Those situations may include, for example, where a company has a multiple year compensation plan or where target levels vary materially between years. Where a company’s disclosure implied that its current or prior year targets were material to an understanding of a named executive officer’s compensation for the last fiscal year or were otherwise material in the context of that company’s Compensation Discussion and Analysis, consistent with Instruction 2 to Item 402(b) of Regulation S-K, we asked it to disclose prior year and current year targets.
When a company discloses that it has used compensation information from other companies to determine its own compensation levels, the company may be engaging in benchmarking its total compensation or other material elements of compensation. Benchmarking is presented in Item 402(b)(2) as an example of information that may be material to an individual company’s compensation policies and decisions. If a company uses benchmarking, and it is material to its compensation policies and decisions, Item 402 requires it “to identify the benchmark and, if applicable, its components (including component companies).”
In a substantial number of comments, we asked companies to provide a more detailed explanation of how they used comparative compensation information and how that comparison affected compensation decisions. Where a company stated that it used comparative compensation information, but retained discretion on how to use it, we asked it to provide appropriate disclosure. For example, if a company stated that it benchmarked its compensation, but it retained discretion to benchmark to a different point or range, or to not benchmark at all, we asked it to disclose the nature and extent of that discretion and whether or how it exercised that discretion.
Where a company indicated that it benchmarked compensation to its peers, but did not identify the peers or provide sufficient details concerning the benchmarking it used, we asked it to identify the companies to which it compared itself as well as the compensation components it used in that comparison. In addition, where a company indicated that it benchmarked compensation to a vague or broad range of data regarding those companies, we asked it to explain more specifically where its compensation fell within that range.
Change-in-control and termination arrangements
We found that a significant number of companies could enhance their Compensation Discussion and Analysis by discussing and analyzing their decisions regarding change-in-control and termination arrangements with the named executive officers. Item 402(b)(1)(v) requires a company to disclose how it determines the amount and formula, where applicable, to pay for each compensation element. Item 402(b)(1)(vi) requires a company to discuss how each compensation element, and the company’s decisions regarding that element, fit into the company’s overall compensation objectives and affect decisions regarding other compensation elements. We asked a number of companies to disclose why they structured the material terms and payment provisions in their change-in-control and termination arrangements as they did. We also asked companies to discuss how potential payments and benefits under these arrangements may have influenced their decisions regarding other compensation elements.
Executive and Director Compensation Tables
We did not detect any common themes in our reviews of the required named executive officer and director compensation tables, the footnotes to the tables, or the narratives that followed them. Overall, we issued relatively few comments to companies on this area of their disclosure. Our comments regarding the required tables generally related to specific disclosure requirements or other information concerning a particular company’s individual facts and circumstances. For example, if it appeared that a company made undisclosed assumptions in valuing option awards, we asked it to disclose those assumptions in the footnotes to the required table or provide an appropriate cross-reference to the discussion of the assumptions elsewhere in the company’s filing. As another example, in the Grants of Plan-Based Awards table, where it appeared that a company did not disclose each grant of an award made to a named executive officer in the last completed fiscal year under any plan, we asked it to do so. Finally, where a company did not disclose the vesting dates of options, shares of stock, and equity incentive plan awards held at fiscal-year end by footnote to the applicable column in its Outstanding Equity Awards at Fiscal Year-End table, we asked it to do so.
Compensation Committee Report
A number of companies furnished compensation committee reports that did not include all of the information our rules require. For example, some companies did not indicate whether the compensation committee reviewed and discussed the Compensation Discussion and Analysis with management. We asked these companies to revise their future reports to include all required information.
Related Person Transaction Disclosure
We issued relatively few comments on related person transaction disclosure. We 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 their policies and procedures. Furthermore, as the Commission stated when adopting the revised rules, disclosure regarding related person transactions is integral to “a materially complete picture of financial relationships with a company,” and we will continue to review company disclosures with this standard in mind.
Our comments on corporate governance matters primarily focused on who was involved in making compensation decisions. We identified a number of areas where a company could provide a more complete picture of which individuals and which procedures it relied upon to consider and determine executive and director compensation, consistent with the requirements of Item 407(e)(3). Where a company’s disclosure was unclear about exactly who made the compensation decisions, we asked for clarification. Item 407(e)(3)(ii) requires a company to describe the role of executive officers in determining or recommending the amount or form of executive and director compensation. Where a company indicated that its principal executive officer had a role in the compensation decision-making process, we asked it to describe his or her role. Item 407(e)(3)(iii) requires companies to disclose the role compensation consultants played in the decision-making process, and we asked a number of companies to do so. In particular, we asked companies to more specifically disclose the nature and scope of a consultant’s assignment and material instructions the company gave it.
1 Those companies that believe their explanation to us should receive confidential treatment should determine whether requesting confidential treatment of that explanation pursuant to Rule 83 is appropriate. SEC Rule 200.83 governs the procedures under which a company may request confidential treatment for information contained in a response letter or for supplemental information it provides to us. Rule 83 requires the company to submit a written request for confidential treatment at the time it provides the information to us.