Speech by SEC Staff:
An Expansive View of Teamwork: Directors, Management and the SEC
John W. White
Director, Division of Corporation Finance
U.S. Securities and Exchange Commission
Practising Law Institute Fourth Annual Directors' Institute on Corporate Governance
New York, N.Y.
September 25, 2006
Thank you, Betsy, for that gracious introduction. As you may recall, although wearing a different hat then, I, like you, had the pleasure of participating in PLI's first Directors' Institute three years ago. It's an honor to be invited back. Since I joined the staff of the SEC last March, I have spoken with groups representing corporate executives and management, disclosure counsel, auditors and others. But this is the first chance I've had in my relatively new role to speak at a program that is dedicated to directors and their unique, and uniquely important, role in corporate America. I am delighted to be here.
The SEC of course takes very seriously its commitment to being "the investor's advocate" in the public sphere. That charge is no less true for all of you who, as directors, directly represent those investors who are the stockholders of your companies. We share common, important interests in that regard, and I think a common understanding of our roles and objectives can be mutually beneficial. In my time during your lunch today, I would like then to talk specifically about the importance of the SEC staff's review of public company disclosures and how understanding that process may be a resource for you as directors. I'd then like to look briefly at several features of the recent executive compensation disclosure rulemaking that are intertwined with your role as directors. Before I do that, though, I need to remind you that the views I'm going to express today are solely my own and do not necessarily reflect the views of the Securities and Exchange Commission or of any members of its staff other than myself. Since I will mention him later, I should perhaps also extend that same so-called "standard disclaimer" on behalf of the Commission's new Chief Accountant and my colleague, Conrad Hewitt, and underscore that the disclaimer makes clear that even if I quote him, Conrad is not on the hook for anything I say.
Understanding Corporation Finance
As Betsy said, I am currently serving as the director of the SEC's Division of Corporation Finance. The SEC of course has four divisions: Investment Management, Market Regulation, Corporation Finance and Enforcement, as well as numerous, no less important, offices. The first two divisions I named Investment Management and Market Regulation attend specifically to the vast worlds of mutual funds and investments companies, of broker-dealers, the stock exchanges, clearing agencies and our capital markets. I realize some of you represent or have experience with companies that move in those special regulatory circles, but my perspective today is that of publicly-held companies more generally, in all industries some 12,000 public companies in total. The Division of Corporation Finance reviews, and oversees to some extent, the public disclosures that those companies must craft and file with the SEC. The Division of Enforcement for its part cuts across all those distinctions and ferrets out and pursues wrong-doers in all areas covered by the SEC's jurisdiction. So individuals and companies that would routinely deal with one of the other three divisions could have Enforcement knock on their doors at any time. For today, I will just hope that your own companies and their executives never warrant the attention of my 1,000-plus colleagues in Enforcement.
So if you're a director of a publicly-traded company, or an advisor to those directors I believe most of you fit in one of those categories or the other what should you understand about the Division of Corporation Finance? To help answer that question, I'd like to talk with you for a few minutes about our disclosure review process, how it works and how you can work with it.
The Structure and Objectives of Corporation Finance
The Division of Corporation Finance is divided into two halves unequal perhaps in size, but certainly not in importance. One half, which we refer to as "disclosure operations", handles our reviews of the filings and disclosures made by public companies; the other half provides interpretive and rulemaking advice and basically does everything else. Disclosure operations, which is my focus today, has 11 different review offices, organized principally according to trade or industry type for example, Telecommunications, Financial Services, Healthcare and Insurance, Natural Resources and Food, and so on. There are teams of 30 to 35 accountants and lawyers in each review office, and each public company is assigned to a particular office. Presumably, many of you are familiar with the disclosure reviews that your companies have undergone with Corporation Finance in the past; these groups are where those reviews happen. There are close to 400 people who work in disclosure operations and approximately another 100 in the interpretive and rulemaking offices, all based at the SEC's headquarters in Washington, D.C.
At various points in the Commission's history, Corporation Finance's disclosure reviews have focused on companies issuing, or selling, public securities, such as IPO's or secondary offerings. These remain an important area of review for us, but we do not stop there. The Division has a long history of also reviewing the regular, periodic filings that public companies are required to provide for their current and would-be investors the 10-K, 10-Q, proxy statement, etc. And after the passage of the Sarbanes-Oxley Act in 2002, this process of reviewing the periodic filings of established public companies became an express charge. Sarbanes-Oxley requires (which is new) that the SEC must review the filings, including specifically the annual report on Form 10 K, of every listed company "on a regular and systematic basis for the protection of investors," and that, for all reporting companies, these reviews take place no less often that once every three years. This means that you can no longer regard the SEC's review of your company as haphazard the luck of the draw it is instead a routine event. I am proud to say that the Division successfully completed its first three-year review cycle last fall, covering all 12,000 public companies. Please understand that I can take no credit for this, given that I was still with all of you in the private sector at that time. But I can say that we are now well into the second round at Corporation Finance and will review close to 4500 companies in the first year of that round which ends this week. One other thought: I said at least every three years. We review hundreds of companies more often than every three years so this is not like jury duty here in New York where you get a pass for a few years after your name comes up and you serve one time.
The Nature of Disclosure Review
But what exactly does "disclosure review" mean and why should all of you, as directors, care? After all, you presumably (hopefully) have competent and well-qualified executives and staff, perhaps even outside counsel or other advisors, who help your company provide disclosure that is useful to investors and complies with all the relevant legal and regulatory requirements. You also all have independent auditors who take a second look at your financial statements after your management has prepared them. All the same, in my opinion there are several reasons why our disclosure review can be helpful to you, as directors, and why you should pay attention to it. I also think it's important for you to understand what that review isn't as much as what it is.
I mentioned the 11 offices that make up our disclosure operations group. And I mentioned our Sarbanes-Oxley charge to review the filings of every public company at least once every three years. As a general matter, you can expect that your companies' recurring reviews will be handled by the same office each time, and you may even have the same staff person or persons processing your filings on a repeat basis. Your financial statements will be reviewed by our accountants; your narrative and other non-financial disclosures may be reviewed by lawyers and other staff as well. At any given point in time, a company's filings may be undergoing review and the company itself may or may not know about that.
When the staff of Corporation Finance decides to comment on a company's public filings (and it does not necessarily do so for every company whose disclosure it reviews), it will typically issue a "comment letter" which will provide you with the staff's thoughts on where your filings could be improved or where the staff feels it needs more information. The company typically will then in turn respond in writing to the staff's points. Often, supplemental conversations between the company and the Division's staff will also take place. Some of our comments may require revising and resubmitting past filings; in other cases, it may be possible to address our comments in future reports. These specifics, and what the staff expects, will come out through the comment process. This process, although private when occurring, will at its conclusion become public, as I will explain shortly.
I imagine some of you may have heard about SEC comments on your company's disclosure in the past. When I was still wearing my private sector hat, I listened to, and sometimes participated in, presentations about SEC comments at corporate board meetings. Notice that I didn't use the word "discussion" but rather "presentation". Unfortunately, I believe the process is often presented to the board assuming it reaches the board at all. And it is presented as an almost adversarial exercise. Almost as a "win or lose," zero-sum situation. The company exalts if it prevailed over the staff's disclosure requests and comments. On some occasions, management may seek to minimize the burden the process places on the directors by minimizing the information conveyed to the board about it. But is that attitude actually helpful to your company, or appropriate for you? Think about the Commission's role and your role, as directors, with regard to investors. How different are they? If you do think about it, you may not want management to "shield" you from the SEC comment process. You may care especially about understanding those areas that have attracted the SEC staff's attention.
I was having lunch last week with the Commission's recently appointed Chief Accountant, Conrad Hewitt, and we were talking about today's program and the remarks I planned to make. I should perhaps let you know that Conrad has served on more corporate boards, and more audit committees, than anyone else I know at least ten at my last count, although not all at the same time of course. Conrad agreed that I could share with you the high premium that he always placed on Corporation Finance's disclosure review comments when he was sitting in your seat and that he shares my belief that directors and not just management or disclosure counsel should be familiar with those comments and should see them as a valuable resource.
A the same time, Corporation Finance's reviews of public company filings are not represented as comprehensive, nor should they be understood as such. If the staff either issues no comments or concludes its review process (after issuing and resolving comments), no one should think that the SEC or the staff is in any way ensuring the health of the company or even blessing the thoroughness or quality of its disclosures. That responsibility remains distinctly with the company and in that sense, with all of you. Corporation Finance's reviews are, however, substantive and frequently substantial. The staff takes time and care to provide thoughtful and meaningful comments. A knee jerk reaction to be dismissive of those comments, or to "fight" them, is seldom, in my opinion, the right response.
I mentioned earlier that the Division's disclosure review offices are organized according to broad industry and commercial categories. As such, the staff members in those offices become very familiar with a cross-section of companies that often have similar businesses and similar disclosure issues. The insight and perspective that come from reviewing the disclosures of multiple companies in many cases over a number of years is another unique value that the staff's comments can offer you and one which I would urge you not to dismiss out of hand. I fully recognize that sometimes a comment may seem off base, or to miss the point, and I've heard counsel relish pointing those out. But in my experience, staff comments often go directly to the heart of key issues (particularly on the accounting side) that warrant the attention of a careful and conscientious board member. Sometimes, even just asking a question (even if not directly on point) reveals a great deal and can lead to improved disclosure. I would urge you to keep an open mind and think about how the staff's comments might advance the needs and interests of your team to the benefit of your investors. I would encourage you (and Conrad would encourage you) to think of the comment letters that we send out as not only being inquiries directed at your company, but also as being a resource for you as a director.
As you all know, you generally must sign your company's annual report on Form 10-K. And if that report is incorporated into a subsequent offering document for a public issuance of securities by your company, then you will have liability for the disclosures in that document with regard to that offering. The Corporation Finance review process and the comment letters we issue are there for you to look at and understand. I would urge you not to overlook them. If I were a director, I would want to make sure I received a copy of each of my company's comment letters and, equally important, the responses my company submitted. Understand the questions the staff has asked, the answers the company has provided and the revisions it has made to its filings. Use that understanding, then, to help set the benchmarks for your company's future disclosures. I do not mean to suggest that directors need to be at the front lines of preparing their companies' public filings. You do need to understand your company's disclosures, however, and this can be one more tool in your toolbox to do that. It will not do the whole job for you, but it can help.
Finally, you should also understand that this same tool is now freely available to your investors, your competitors and any other interested person. This is a relatively new phenomenon. But after a particular review is completed, the staff of the Division of Corporation Finance posts its comment letters, and the responses it received from the company, on the SEC's website where they are searchable and retrievable by the public at no cost. I am sure your management and their advisors understand this, but it's one more thing to keep in mind when crafting responses to my staff's comment letters. One day, your neighbor may read them. And more importantly, your own bosses, your shareholders, may as well.
The Interpretive and Rulemaking Offices
I referred earlier to the other "half" of Corporation Finance the interpretive and rulemaking offices. And although my focus this morning has been on disclosure operations and their review of your companies' filings, I would be remiss if I did not at least mention the important work done by these other offices in my Division. These are the people who support disclosure operations and provide interpretive and other specialized guidance and services to the Commission, to investors and to America's public companies. You will find our Office of Rulemaking here, for example. The Office of Chief Counsel, for its part, is the entry point whether by phone or letter for questions that public companies and their advisors, or other interested parties, may have about the applicable securities laws and regulations. Our Office of the Chief Accountant, which is distinct from the Commission's Office of the Chief Accountant, operates in this "half" of Corporation Finance and provides accounting and financial reporting expertise when complex disclosure situations present themselves in those areas. We have an Office of International Corporate Finance which deals exclusively with the special circumstances and needs of the foreign registrant community. We also have an office devoted solely to Mergers and Acquisitions and the related disclosures and filings that go with those transactions. Another office deals with Small Business Policy, and so on. For all of you, your company may at any point in time find one of our specialized interpretive offices to be a resource for you or they all may operate relatively silently in the background from your perspective. Unlike disclosure operations, there is no required recurring interaction between any of them and any of you.
In the past 20 minutes or so, I have talked with you about how Corporation Finance and the work we do can overlap with your own interests. Each of you, by virtue simply of being a director of a public company, has a responsibility for understanding your company and its disclosures. (Obviously, you have a number of other responsibilities as well.) I hope I have also given you a sense of the many important responsibilities that the staff of Corporation Finance shoulders, and I hope what I have said has given you some insight into how the staff approaches those responsibilities and how our work might in turn be a help to you. Although I have only had the pleasure of working in the Division for six months myself, it's important to me to take a moment of your time to emphasize how proud I am of each and every member of Corporation Finance for the contributions they make each and every day. They truly give meaning to the concept of being "the investor's advocate."
In the next few minutes, I'd like to talk briefly about a few pieces of the Commission's recent executive compensation disclosure rulemaking and what I see as some of the more significant intersections that this rulemaking has with all of you as directors.
As we heard from the panel that preceded me and as I'm fairly confident you all already knew the Commission adopted significant revisions to our rules for executive compensation disclosure two months ago tomorrow, on July 26. I recognize that all of you, and especially those of you who serve on compensation committees, have a keen interest in, and responsibility for, the substance that is, the amount and form and nature of your executives' compensation. Overseeing and compensating those executives are some of the most important things you do as a board. The Commission's interest in executive compensation, however, is all about disclosure. The Commission takes very seriously its often repeated pronouncement that it is not in the business of setting executive compensation not even in subtle ways nor is it in the business of judging companies or boards about the decisions they make in this area. Our purpose and our role at the SEC do obviously intersect with your own, however, in this sense: we have crafted our rules and we will monitor their implementation with the goal in mind of helping investors obtain the information need about the compensation decisions that you make. Investors can then judge those decisions how ever they choose they are, after all, the owners of the company and the ones ultimately paying those bills.
The details and meanings of our recent rulemaking, and the disclosures that we expect to see, have been receiving a great deal of attention at various programs, including this one, and I'm sure that this will continue to be true in the coming months. I do not have the time today to review our rules in any depth, and you have already heard from an excellent panel on the topic. I believe that everyone should understand and remember, though, that the SEC's rulemaking was substantial and comprehensive. The structure and requirements of the Summary Compensation Table have been meaningfully revised, and companies will now be required to present one number reflecting total compensation for each named executive. As Chairman Cox pointed out at our open meeting in July, "among the most important features of these new rules is that there will now be one bottom-line number, including all options, for an executive's total compensation. And that number will be comparable from company to company."1 I would, of course, echo the Chairman and I personally anticipate that this will be a critical piece of the disclosure that investors will start receiving in the next proxy season. The Commission also adopted rules requiring disclosure of director compensation (including a requirement to provide one total number), significantly revising our rules for disclosure of related party transactions and revising our rules and providing more interpretive guidance for perquisites disclosure (including perquisites provided to directors). The SEC also provided substantial guidance on disclosure of practices pertaining to stock option grants to executives (and, again, to directors). Obviously, I cannot go over all of these changes today, but I would like to zero in on a few of the ways in which I see our recent rulemaking as particularly affecting directors.
Compensation Discussion and Analysis
I imagine you are all familiar with the old "Board Compensation Committee Report on Executive Compensation" that used to appear in the proxy statement. As its name suggests, it was a report by the compensation committee not the company or management. As the Commission had proposed last January and you heard this morning, that report has been eliminated and a new, principles-based Compensation Discussion & Analysis (or CD&A) section is now required in your company's proxy statement and annual report on Form 10 K. In addition, a new and very different Compensation Committee Report will also be required going forward.
The new CD&A section is at the heart of the new rules. In the most summary terms, it is designed to be a principles-based overview explaining the policies and decisions related to executive compensation. That principles-based theme is critical to our recent rulemaking and one which I have been stressing in other forums when speaking about the new rules. If you are interested in this quite important topic and its intended impact on your company's disclosure, I would refer you to a speech that I gave three weeks ago at another PLI program devoted almost entirely to the new rules2. In those remarks, I tried to lay out the meaning and significance of a principles-based approach and how embracing it can aid both investors and companies. Among other things, that speech, entitled "Principles Matter", takes a look at what "principles-based" means specifically with regard to the new CD&A. Those remarks are available on the SEC website, and I also saw copies out at the registration desk this morning. Today, however, I'd like to focus on another facet of CD&A how does it fit in the scheme of your company's public disclosures overall?
As the phrasing of that question subtly acknowledges, CD&A is your company's disclosure, not your board's or your compensation committee's. And, as company disclosure, it will be covered by those famous certifications that your CEO and CFO must make for your company's annual report on Form 10-K. So, as you can imagine, management at your company and those charged with crafting and signing off on your company's disclosures may now have a heightened interest in the CD&A, at least compared to the interest they had in the old board compensation committee report that has been eliminated (and which was not subject to the certifications). At the same time, executives who are personally covered by the disclosure rules can be expected to have a continuing and still heightened interest in what exactly the company discloses about their individual compensation. Investors seem to have a heightened interest in all of the above. In crafting the final rule, we at the Commission heard investors when they told us in their comment letters that they continue to have a heightened interest in what all of you, as directors, are doing, and that they still wanted to hear from compensation committees directly. Investors did not want the board to be divorced from the company's disclosure about executive compensation just because of the new format. Which takes me to the new Compensation Committee Report.
The new Compensation Committee Report was modeled on the Audit Committee Report, which has already been required (in a totally different context of course) by the Commission's rules for several years. In form, the Compensation Committee Report is very simple. It needs to contain only two thoughts. First, it must contain a statement as to whether the compensation committee has reviewed and discussed the Compensation Discussion and Analysis with management. Second, it must say whether, based on such a review and discussion, the committee has recommended that the CD&A be included in the company's annual report on Form 10-K and proxy statement. Unlike the CD&A itself, the new Compensation Committee Report will appear over the names of the compensation committee members and will be furnished, not filed. Now that may seem to some a technical, legal distinction but its importance for what we're discussing today is that your CEO and CFO will not have to certify your compensation committee's report. Nor will your company have the same liability with regard to the report as it does for company disclosures that are filed. I would suggest, however, that as board members, and particularly if you are compensation committee members, you should not take that report any less seriously.
I tried to suggest in the first part of my remarks today how you might look to SEC staff comments in the review process to better do your job as directors. Strengthen your team how ever you can. I would similarly encourage you to have an expansive approach to how you, as directors and here I am speaking especially to compensation committee members can work with management to enhance both the substance of your company's executive compensation disclosures and the procedures you follow for generating them.
I mentioned very briefly that your CEO and CFO will now be called upon to certify your company's Compensation Discussion and Analysis. As I also said earlier, that section of your company's disclosure must address the policies and decisions related to executive compensation. One objection that we heard to having that section be company disclosure is that it unfairly makes the CEO and CFO responsible for board and compensation committee actions that are outside the officers' "jurisdiction", for lack of a better word. Your compensation committee report, as well as any consultations and discussions you may have about your CD&A section, can help provide your officers with the necessary insights and understanding they need in making their certifications. And this, in fact, is a two-way street. Your own comfort and your own knowledge can be equally fortified and improved through this process. And if you become more involved and more adept with these issues, that will inure to the benefit of your shareholders and investors more generally, which of course comes full circle to your overlap with the SEC. The Commission has carefully structured a disclosure system in this area designed to further the interests and address the needs of investors. I hope you can see it in many ways as also offering the potential of furthering your interests and addressing your needs as directors. One important footnote I would encourage you again to take a look at my remarks on principles based disclosure. They highlight and explain this crucial concept and, I believe, may help you and your company in drafting and evaluating your CD&A sections in the future.
Compensation and Other Disclosures about Directors
Finally, I just wanted to quickly point out one other area of our recent rulemaking that undoubtedly intersects with all of you the company will now be required to tell its investors significantly more information about you, as directors, including your total compensation. Director compensation for the last fiscal year will now be required to be disclosed in a new Director Compensation Table (along with related narrative), which will be similar in format to the Summary Compensation Table that is the primary vehicle for disclosing the amounts of your executives' compensation. As with executives, companies will be required to disclose one total number for a director's compensation, which will include the dollar value of option grants to directors and perquisites, among other compensation. And don't forget what I was saying earlier about the CD&A and principles-based disclosure. As appropriate, companies will need to consider providing narrative disclosure about director compensation that is analogous to that found in the new CD&A. Our new rules for director compensation disclosure (and some exceptions) are comprehensive and fairly detailed. I would encourage you to get more advice about them if you don't feel in command of the subject today. I spoke a few moments ago about various flash points of heightened interest that we might anticipate for persons in various positions; here is another possible one for all of you, individually, as directors.
There are also multiple other ways in which your company's disclosure may be required to talk about you. Our rules require disclosures about director independence and how the board made its determinations in that area. You should all also understand, whether you are on the compensation committee or not, that the company will now be required to provide disclosure about that committee's processes and procedures for the consideration of executive and director compensation. Our rules for disclosure of related person transactions, which also apply to you, have changed. Again, if you have not yet been well-briefed about these (and other) aspects of the recent rulemaking, I would strongly encourage you to get that information, ask any questions you have, and make sure you understand the various ways in which your company's disclosure going forward will be expected to speak about you. The better you understand it, in my opinion, the more you can do to help ensure that your company will provide your investors with the high quality, clear and useful disclosures they deserve.
More than ever before, you are today doing your jobs as directors very much in the public eye. And the investors who elected you to your important positions are relying on you and your leadership. Investors and the Commission may have great expectations for you, and may place great demands on you, but I hope I have shown you today a couple of ways in which you are not alone as you take up the important tasks before you. I hope you will embrace an expansive view of who and what may contribute to your team and its efforts, and how the SEC, its staff and even its rules may facilitate your success rather than standing as obstacles in your path.
Thank you for sharing your time with me today. I wish each of you much future success on behalf of America's investors.