Speech by SEC Staff:
Keeping the Promises of Leadership and Teamwork: The 2007 Proxy Season and Executive Compensation Disclosures
John W. White
Director, Division of Corporation Finance
U.S. Securities and Exchange Commission
27th Annual Ray Garrett Jr. Corporate and Securities Law Institute
May 3, 2007
Good morning. Thank you Mark [Gerstein] for that gracious introduction. I also want to thank Northwestern Law School for the invitation to speak today. I am very happy to be here, which for me is my second visit to the Ray Garrett Institute, now in its 27th year. Just like its namesake who served as the chairman of the SEC from August 1973 until October 1975,1 the Institute stands out as a real Midwestern leader in its field. It is my privilege to speak with all of you here today and I hope I can do justice to those standards of the former Chairman and of the Institute.
Last year, Martin Dunn, Deputy Director of the Division, gave the keynote speech at this conference. I was rereading his remarks this weekend. Fortunately Vice-Chancellor Leo Strine is the one who actually has to follow in Marty's footsteps, because that is a hard thing to do. Marty gave an enlightened (and humorous) review of how the Division should and does recommend rules in an enlightened manner. He closed with a paragraph that outlined the four pending rulemaking projects for the Division at that time and concluded that they all met that enlightened standard. Those four projects were the best price rule amendments, foreign private issuer deregistration, electronic proxy and executive compensation disclosure. I am proud to say that one year later the Commission has successfully completed its rulemaking in those four areas. In the case of one of those rulemakings, not only is it completed, but it is already fully in action. It is grabbing daily newspaper headlines. It is a leading topic of conversations in board rooms and chat rooms alike. What topic? Executive compensation, of course, and the wave of new disclosures that are coming out this proxy season in light of the rules which the Commission adopted last summer.
Like anything that is both prominent and substantive, the SEC's new rules for executive compensation disclosure have found both great fans and great detractors. The same is true for the disclosures that have arisen in response to those rules. With my time this morning, I would like to step back and cut through some of the recent rhetoric to take a look at where we are today with the rules and the accompanying disclosures, and what that might tell us about where we're going or where we may need to go. Before I do that, though, I should remind you all that I am speaking today only for myself and the views I express do not necessarily reflect the views of the SEC or of any members of its staff other than myself. The SEC as a matter of policy, of course, disclaims responsibility for the private statements of any of its employees.
When asked in a recent interview what his proudest accomplishment had been since joining the Commission, Chairman Chris Cox without hesitation invoked the new executive compensation disclosure rules. They truly have represented a sea change in the disclosures that public companies provide their shareholders about the compensation that they pay to their own leaders, their CEO, CFO and the three other most highly paid executives. I have been at the SEC for only a little over a year—so it may be easier for me—but I would also cite the executive compensation disclosure rules package if someone asked me what was most remarkable and noteworthy about my time at the Commission.
We are just now beginning to see the vast wealth of new information that these rules are providing investors. Both the fans and the detractors that I just mentioned are absorbing and analyzing the new data, and we are still early in that process. I think we can all agree, however, that the new rules have made a difference and are having a real impact for our markets and the investing public. And they are producing disclosure that is grabbing headlines almost every day.
As I talked repeatedly about last fall, the commitment of public companies and their advisors to take up the new rules and make them meaningful in practice has been a critical facet of this new paradigm. I have also talked frequently about the Division's teaming with the private bar and public companies to try to elicit the most useful and valuable disclosures that we can on behalf of investors. Many in the private sector seem to have embraced that challenge, and I believe we are beginning to see the fruits of our efforts. Through published interpretive guidance, public speaking on the topic, and the various phone calls and questions we have answered, the Division has also been trying to do its part.
That continues now as we are beginning to see the first wave of proxy disclosures made under the new rules. I have mentioned it in various other forums, but let me point out again that the Division has undertaken an important project of reviewing the disclosures filed under the new rules by a critical mass of companies. We also intend to publish a report on those reviews this fall for the benefit of the public as well as companies that did not have their own disclosures reviewed this time. (So stay tuned for that, and see if you agree that we are doing our part. And if you don't, please let me know.)
Talking with you today, I truly do not know what our review report will say, or how this season's disclosures will be evaluated in the final analysis. We can take some early snapshots of how the rules are working, however. As we all know and I have acknowledged, there are some vocal critics, and their criticisms should not be dismissed out of hand. At the same time, there are many things I find to be positive about the new rules and the disclosures that are emerging under them. With those equities in mind, I thought I would take up some of what we've been hearing and try to think about some discrete items (often complaints) in a more balanced way.
Analysis (or lack thereof).
We have already all become accustomed to talking about the new "CD&A" but there have been complaints from some quarters that companies have forgotten what the "A" in "CD&A" stands for, that CD&A—Compensation Discussion & Analysis—is devoid of "analysis". Various public commentators have lobbed in this criticism, and it is one thing that the staff of Corporation Finance will be considering as we undertake our reviews of disclosures for this first year. CD&A disclosures may not yet be quite where they should. At the same time, in my opinion today, many companies seem to have made a good faith attempt in this regard. These are new rules and their "principles-based" nature represents a fairly dramatic shift for disclosure in this area.
The Commission explained CD&A in its release adopting the new rules, and you need look no further to understand what Corporation Finance will be looking for when we review the new disclosures.
The purpose of the Compensation Discussion and Analysis disclosure is to provide material information about the compensation objectives and policies for named executive officers without resort to boilerplate disclosure. The Compensation Discussion and Analysis is intended to put into perspective for investors the numbers and narrative that follow it.2
CD&A is a striking new piece of the compensation disclosure landscape but I would also encourage everyone to see it as an opportunity and to embrace it as such. As I noted a moment ago, the new rules require that a lot of new information be disclosed. CD&A is the company's chance to put that information in context and to help investors make sense of it all. Chairman Cox perhaps put it most succinctly and eloquently in his opening remarks at the Open Meeting for adoption of the rules, when he stated that "[CD&A] will give companies an opportunity to explain their compensation policies, and to share with investors how they arrived at the particular levels and forms of compensation for their highest paid executives."3 When we look at your CD&A disclosures, Corporation Finance will be looking to see if you've answered the "how" (as Chairman Cox said) and the "why" questions rather than merely the "who, what, where and when". The reviews that Corporation Finance has undertaken, along with our corresponding report, may ask for a higher level of analysis in CD&A. I don't know yet. But we do understand that this is the very first year for CD&A. Our expectations for the second year will be higher.
There has also already been some clamoring for the Commission to amend its rule (S K Item 402(b)) on CD&A in order to force more analysis. Typically these critics want to make the rule more prescriptive and to abandon the principles-based mandate that the Commission put in place last July. I have my own doubts about the effectiveness of such an approach. I cannot say, obviously, that the time will never come for such a rule change, but in my opinion, we are not there yet.
The Question of Length.
One of the most frequent complaints I have been hearing (and the press has been reporting) is that the new disclosures are just too long. And not only are there too many words, but those words are too dense and are housed in sentences that are too complex. Chairman Cox has looked at this himself and has lamented what he sees as a failure of "plain English."4
I am a big believer in plain English and in well-written, clear and concise prose. It was one of the key topics that I included in the remarks I made last September to kick off the Division's outreach to the private sector on the new executive compensation disclosure rules.5 All the information in the world is of no use if no one can understand it. There are several projects underway to craft an example or model of plain English disclosure under the new rules. I look forward to seeing what comes out of those projects. But I would not overlook the fact that some public companies are already modeling plain English in their executive compensation reporting.
I also think that criticisms of the length and language of the new disclosures can go too far. One of the primary drivers of length of the disclosure in proxy statements is that executive compensation itself tends to be very complicated and varies significantly in form and function, in spirit and letter, from company to company. Even if plain English principles are faithfully applied, under the new rules there may very well be substantially more disclosure required overall.
Our new rules require a considerably larger amount of information now than in the past. For example, we are seeing new and in some cases very detailed or extensive disclosure about:
- severance and change-in-control arrangements
- pension benefits and non-qualified deferred compensation,
- option grants and other equity awards, including outstanding holdings
- timing of option grants, and
- director compensation
Just as a few examples. To my mind, this is a good thing and is responsive to the needs and stated desires of investors. We are now learning all kinds of things about public companies and their executives that were rarely if ever shared with the public in the past. Some outside commentators, including some in the press, have criticized the new disclosures for being overwhelming or for needing to be "sifted through" in order to find the desired bits of information. Ironically, though, those same commentaries and articles then highlight various sorts of specific information and details that the authors find important or interesting to them, such as exercises of stock options or withdrawals from deferred compensation plans. These commenters seem to argue that the Commission should have required a smaller subset of information than it did—of course, they want exactly the subset that is of interest to them. That their neighbor has an interest in some completely different subset seems lost on these commenters.
Criticisms of the length and language of executive compensation disclosures tend to be fairly amorphous complaints. It is also not necessarily clear—if you agree with those criticisms on their merits—whether the problems or weaknesses leading to those complaints are rooted in the rules themselves, or in companies' failure to comply with the rules. I would urge people to keep in mind, though, that the Commission was seeking to establish a "layered" disclosure approach, with CD&A as the top layer. Disclosure is intended to be available for the many types of investors and users of proxy statements, but as you drill down, not all of that disclosure will be relevant to all readers. This may lead some to conclude that the disclosure provided on some topics is irrelevant or excessive or both, and that the information made available regarding those matters is therefore either "buried" or in turn obscures other, more meaningful disclosure. Not every layer is going to be interesting to every reader. But ideally every reader will be able to find more of the information that he or she needs and with the new CD&A which we just discussed as the guide, the reader will have the context in which to understand the rest of the admittedly expanded information that companies are now providing.
Looking broadly at the new disclosure packages, a few things seem clear. CD&A is providing a new insight into executive compensation at public companies. Those disclosures may need some refining—certainly some critics are insisting on it—but the CD&A is proving it can be a real resource for investors. Both with the CD&A and elsewhere, companies are now providing a much greater breadth and depth of disclosure than they did in the past. This is part and parcel of the dreaded length criticism—but there seem to me to be tremendous gains here as well. But what about the specific things that are making up that length? The new tables and accompanying narratives. How should we feel about those individual disclosures? In the time remaining for my segment this morning, I would like to talk about a few discrete areas of disclosure that have been the focus of particular scrutiny (and occasional complaint): disclosure of performance targets when they are material, including alternative disclosure when the specific targets may be excluded; the use of "negative numbers" in the tables; disclosure about the role of the CEO; and disclosure about perquisites.
1. Performance targets. Our rules are quite clear on this one, and at least at first blush, it seems like they are also quite unpopular among some. Companies do not seem eager to disclose their performance targets as we have set up in our rules. Early reports suggest that less than half of reporting companies are disclosing specific performance targets used in awarding annual bonuses or long-term incentive pay. Of course, some companies may not use performance targets; others may rightly be relying on the confidential treatment exclusion provided under our rules. Others, though, may be failing to make the required disclosures.
The staff has heard an almost unanimous chorus from investors—confirmed privately by many in-house and law firm counsel—that companies are not providing required disclosure about performance targets in some cases. That too many companies are invalidly claiming the confidential information exclusion. In other words, some companies may be incorrectly asserting that they would suffer competitive harm if they provided the required material disclosure about performance targets used for executive compensation purposes. This is obviously something that the staff in Corporation Finance will be taking a very hard look at. Investors have made it very clear that they want this information and that it is quite material to them. I am not interested in suggesting any loosening of the confidential treatment standards. We have great respect for those standards in the Division of Corporation Finance. At the same time, though, public companies need to employ the same respect for the rules as we do, and not try to claim cover from them if the company's facts do not in fact fit within the rules. And as part of our review process in Corporation Finance, the staff will be prepared, as appropriate, to ask companies to justify their use of the exclusion. Companies that are using the exclusion and therefore not disclosing their specific performance targets should be prepared to provide the staff with an open and full explanation of those decisions and those targets.
2. Alternative disclosure when performance targets may be excluded. I am also hearing what sound like valid concerns about the disclosures that are being provided by companies that are claiming the exclusion for confidential information. If the targets are in fact protected by this exclusion and thus do not need to be disclosed, then the company still must provide investors with a sense of how hard the targets are to achieve or how likely it is they will be met. This is again key information for investors. They want to know whether or not the targets are real targets or are more akin to shadows and are going to result in essentially guaranteed awards. I am not impressed by disclosure that targets "are difficult but possible to achieve" without more. Another complaint I have heard relates to identification of targets simply as "intended to encourage superior performance". Is there any target for which that is not true? Without more, identifying a target simply as "challenging but achievable" or as "designed to promote excellence and motivate management" seems an empty disclosure that I would not think is useful to investors. And again, this is a specific area at which the Corporation Finance staff will take a close look in reviewing this year's proxy disclosures. And I think it's possible we could consider whether it would be appropriate to recommend rulemaking on this one to recalibrate the rules
3. Negative numbers. We have heard some concern about the impact that "negative numbers" have on reporting under our new tables. Negative numbers arise, for example, from the decrease in actuarial value of pension plans or from various calculations that must be made with regard to compensation cost from equity-based awards (such as expensing of options). These negative numbers then feed into aggregate calculations which must be reflected in our tables and in some cases, but not all, may result in a negative amount being reflected in a column itself. In thinking through these disclosures, we had to make choices in our recommendation on final rules to the Commission and through reasoned analysis and consideration of public comment, we ended up at a position that in some cases allows offsets (those negative numbers get netted in the mix) but restricts the presentation of negative numbers as a total. In other situations, a negative number appears in the table and feeds into total compensation. Some people agree with one approach, some agree with another. Some have complained that they are not able to get clearly the information they want. Or that companies have determined their named executive officers on the basis of information that unhelpfully includes those offsets and negative numbers. Complaints about the disclosures presented though are really complaints about our rule choices. We will evaluate those based on actual practice under the rules and what the impact has been. Certainly we are very interested in listening to what others have to say in this area.
4. Disclosure about the role of the CEO. For the most part, I am heartened by the robust disclosures that are emerging under the new rules, and I believe the leaders of America's public companies have stepped up to comply with their disclosure obligations and to provide meaningful information to their shareholders. I have heard worries though that the leaders at the highest level, America's CEO's, are not embracing the call to provide robust disclosure about their own roles in their companies' compensation processes. Clearly this is something our rules now require. Did the CEO have the ability to call or attend even portions of compensation committee meetings? Did she meet with any consultants used by the compensation committee? Did the CEO retain or have access to any other compensation consultants who influenced the company's executive compensation? What input did the CEO have as compensation packages were being crafted? These are just some examples of the types of principles-based questions that companies should be asking and then considering disclosure of the answers. A review of the disclosures we've received will help us understand how this all is playing out. And I hope we will find that America's CEO's are listening to their counsel and advisers who are urging them to comply with the principles and to provide robust disclosure in this area as well as others. But, as you can perhaps tell, I have some initial concerns.
5. Disclosure about perquisites. This is another principles-based area, and I believe our new rules are pretty clear about how perquisites should be evaluated and disclosed. I also believe the new rules are making a real difference. I found interesting the study that Paul Hodgson of The Corporate Library has done of the new perks disclosures. In short, he found that many companies are disclosing considerably more perks this year than last. The triggers for our rules and our disclosure requirements in this area are a good example of our changes provoking meaningful, new and expanded disclosures. Yes, this in some instances has added to length and to the quantity of disclosures. But with regard to perquisites, this seems clearly to be of interest and importance to investors. And again, we will see what the review process finds.
At the beginning of my remarks I mentioned the Corporation Finance review project and report that you can expect us to publish this fall. Clearly giving feedback on the disclosures this year is a key objective for us and something we hope will be useful to public companies as they prepare their disclosures for their second proxy season with the new rules. We will also be considering if there are any changes to the rules that might be advisable, and the Division will then recommend those to the Commission for proposal as appropriate. Should we revise the way the rules treat negative numbers? Should the rules for disclosure of performance targets be refined? I do not know the answers today, but we are certainly studying these and other questions like them. If there are common questions that are coming up and which the staff can answer, we will also try to do that. So our reviews and the final report are a learning project for us, as well as hopefully for the public.
As I noted earlier, the SEC staff, and especially myself, have asked the private sector to do its part to generate and provide the quality disclosures to which investors are entitled. And we are appreciative of what has been done. We also understand there has been an added challenge to that because of the principles-based nature of the new rules. Corporation Finance intends to continue doing its part as well, which includes a sensitivity and respect for the principles-based nature of the new disclosure regime. That does not mean we will not comment on disclosure deficiencies and failures when we think we see them, however. Or that we will not ask hard questions. As with our review process generally, some of our comments will be satisfied by future disclosures, but some companies may find themselves needing to file amended Reports on Form 10 K this year. We are taking all of this very seriously.
I have spent much of my time today, as I do every time I speak these days, talking about disclosure. It is the heart and hallmark of our work in Corporation Finance. But I do not think we can or should deny the ripple effects. As these new, enhanced disclosures are being made, corporate America and its shareholders are taking note. And talking more. Perhaps that increased dialogue is another positive consequence of the new rules. Those in the private sector are not the only ones taking note and taking part in the dialogue of course. There were many shareholder proposals this year with non-binding proposals relating to executive compensation. President Bush spoke last winter in New York about executive compensation. Even Congress has joined the debate. Less than two weeks ago, the House of Representatives, led by Representative Barney Frank, passed by a 269–134 margin a bill to give shareholders a nonbinding vote on executive pay disclosures and change of control packages. I believe Senator Barak Obama has introduced an identical bill in the Senate. Clearly executive compensation will remain one of the hot topics of the day in corporate board rooms, in chat rooms, and even in Washington. I believe the Commission's leadership in adopting its new disclosure rules has made a positive contribution to that public dialogue and I look forward to its future iterations. On a smaller note, I have very much enjoyed talking with all of you about this topic today, and I look forward to the panel discussion that follows. Thank you again for the invitation to be here and for your time and attention. I would be happy to take any questions you might have.