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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Executive Compensation Disclosure and the Important Role of CFO's


John W. White

Director, Division of Corporation Finance
U.S. Securities and Exchange Commission

CFO Executive Board
New York, N.Y.
October 3, 2006

Thank you Silvio. I am very pleased to be here today at this dinner meeting of members from the CFO Executive Board. I very much appreciate your giving me a bit of your time to talk with you about an area of considerable current interest at the SEC — executive compensation disclosure. As I will explain in a moment, I am particularly focused this evening on the fact that each of you is the principal financial officer (as our rules at the SEC refer to you)1 of a major public company, and I am hoping executive compensation disclosure is an area of interest for each of you. I certainly think it should be — perhaps even more so than you've realized thus far. CFO's play a very important role in America's businesses and in fact to our economy as a whole, as I have no doubt you all appreciate. The Commission's executive compensation disclosure rules also acknowledge this fact in multiple ways, as I will try to explain.

Before I go any further into my remarks, however, I need to share with you all the so-called "standard disclaimer" that applies to SEC staff remarks. As a matter of policy the SEC disclaims responsibility for any private comments or speeches from its staff. You should understand that my remarks this evening represent only my own views and not necessarily those of the Commission or of other members of the staff.

So my topic this evening is the Commission's recently adopted and significantly revised rules for executive compensation disclosure. The Commission adopted these final rules at an open meeting on July 26, 2006, and in the intervening two months, I have already had the opportunity to spend many hours addressing various groups of lawyers, compensation specialists, management, and last week even directors about what they should expect from the new rules and what the rules will be expecting of them. It is very important to me, and to the Commission, that all the necessary players are on board and on the team as these new rules go into effect for the next proxy season. All of you — as chief or principal financial officers — have a special place in that mix. Tonight, I would like to lay out briefly for you where I see some of the key intersections between the new rules and your own positions as CFO's.

First, however, I need to make one thing very clear and to delineate the SEC's role and place from various other voices that are being heard increasingly loudly about executive compensation. I have already used the word "disclosure" a couple of times this evening, and I really want to emphasize that the Commission's new rules are all about disclosure. I believe the Commission and its staff take very seriously the charge — as our Chairman, Chris Cox, has made clear2 — that the Commission is not in the business of setting executive compensation. Not even in subtle ways. Nor is the Commission in the business of judging companies or boards about the decisions they make in this area. The Commission is, however, strongly committed to helping investors get the information they need (through required disclosures for public companies) about executive compensation so that shareholders and investors can judge that, how ever they choose and react how ever they like.

I also believe that the Commission is quite genuinely not trying to judge, change or affect the compensation of anyone in this room. That does not mean, of course, that our new rules will not have a substantial effect on all of you and on your colleagues in your companies' executive suites. I believe they will. I would like to look at three specific ways in which you can (and should, in my view) be involved in all of this:

  1. Your involvement in the substance of your company's disclosure, particularly the new Compensation Discussion & Analysis;
  2. Your involvement in refining and adjusting your company's disclosure controls and procedures; and
  3. Your involvement with your board's compensation committee and its new Compensation Committee Report

CFO's and the Substance of Executive Compensation Disclosure

So first of all, the substance of the new rules. I have no intention of getting into the weeds and taking you through the details of required disclosure going forward. I know you all have many others to help you on that score and who will be at the front lines for your companies in compiling the necessary information and preparing the company's disclosure. But there is one key point that you all should know — under the new rules, companies will be required to include disclosure in their proxy statements about their CFO's compensation. This is new, and it is irrelevant how much or how little any of you might make.

The old rules required compensation disclosure about the CEO (as a category) and the four other most highly compensated executives, calculated based on salary and bonus. The new rules, which become effective in December and for most of you will apply to your next proxy statement — will require disclosure about the compensation of the CEO and the CFO (by titles, or categories) as well as the next three most highly compensated executives. Under the new rules, the amount of compensation used to calculate the three highest is based on everything with a few limited exceptions. Importantly it is not just salary and bonus. So this figure includes the dollar value of option grants, the value of perquisites, and numerous other types of awards.

And if this thought horrifies you, please understand you won't be spared even by giving up your title or quitting your job. Disclosure will be required about anyone who served as the CFO, or CEO, during any part of the year. And if you should leave, any severance you receive will be included in your compensation disclosure.

The release the SEC put out with its new rules is entitled "Executive Compensation and Related Person Disclosure" and covers substantially more than proxy disclosures of executive compensation (although that's critically important and is the central topic of the rulemaking). Just as a quick overview and summary, the final adopted rules cover:

  • executive compensation disclosure, including, among other things,
    • new tabular disclosure (with a single compensation total)
    • a new Compensation Discussion & Analysis section, which I will turn to in just a minute
    • perquisites guidance
    • disclosure about post-termination (retirement or otherwise) or change-in-control payments
  • disclosure of related party transactions
  • disclosures about the compensation committee, about director independence determinations and other related corporate governance matters
  • director compensation disclosure
  • disclosure about security ownership of management and directors, including shares pledged by management
  • new rules and guidance about disclosures of stock option grants and option grant programs, plans and practices

I'd be happy at the end of my remarks to talk about any of this in more detail if you have any questions. I also hope that perhaps some of you will be newly motivated after I stop talking to make sure someone at your company or on your team keeps talking and fills you in on what you should know and what you want to know.

Compensation Discussion & Analysis (CD&A)

I do want to make one other last point under this broad "substance" umbrella. You may have heard that proxy statements under the new rules will be required to include a new "Compensation Discussion & Analysis", or CD&A, section. That section will also be deemed "filed" and will be incorporated into your company's annual reports on Form 10-K (more on the significance of that in a moment).

The new CD&A section is at the heart of the Commission's new rules. Given your CFO perspective, I know you are already very familiar with MD&A, or Management's Discussion & Analysis. CD&A will bear many similarities to MD&A, albeit covering a different subject matter. In the most summary terms, CD&A is designed to be a principles-based overview explaining — that is, "discussing and analyzing", or the "D&A" part — the policies and decisions related to executive compensation. And as CFO's, you should particularly appreciate the meaning of principles-based disclosure, as it is not only central to MD&A but is also a close relative of the principles-based standards that are so much in focus lately in the accounting and financial reporting worlds.

The principles-based theme is critical to our recent rulemaking and one which I have been stressing in other forums when speaking on this topic and trying to explain how it works in the disclosure arena. When trying to explain how it works, I personally have found it useful to look at a 2002 speech on principles-based accounting that FASB Chairman Bob Herz gave.3 If you are interested in this important element of the new rules and its intended impact on your company's disclosure, I would also refer you to a speech that I gave three weeks ago here in New York. 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.4

And, more importantly, in this compensation world which is often dominated by lawyers and compensation specialists of all types, you as CFO's bring a different perspective. As I have said, you are presumably familiar both with MD&A (and how it works) and with the principles-based theme from the accounting world. I hope you become involved and take a leadership role in this new and critically important disclosure that your company will be preparing and giving its investors for the first time in the coming months.

Disclosure Controls and Procedures

I'd like to put the content of the new rules aside now and talk for a moment about process. I have to assume you all have spent much time in the world of internal control over financial reporting (the famous SOX 404). I also assume you are familiar with the related requirement that public companies maintain disclosure controls and procedures which apply to all information filed or submitted to the SEC. Among other things, I assume you're very familiar with these controls because they should be feeding into and contributing to your ability to make the certifications that are required of each of you, as a CFO, under Section 302 of the Sarbanes-Oxley Act.

I alluded earlier to the new and expanded types of compensation information required by the new rules. To my mind, a company needs to be reviewing and, where necessary, revamping its disclosure controls and procedures to make sure that those are up to this task. I imagine many of you already have done so, or hopefully have at least substantially started that process, since information from this year (all the way back to the start of the year) will be required to be disclosed in the next proxy. And remember there are two separate and distinct reasons, both related to your certifications, that you should especially care about disclosure controls and procedures.

  • As I said earlier, your company's disclosure controls and procedures provide much of the support you need in making your required certifications (and don't forget your 906 certifications for that matter, on which you have personal criminal liability); but also
  • Your Section 302 certification specifically speaks to your responsibility for disclosure controls and procedures and to you, as CFO and a certifying officer, having evaluated those and disclosed your conclusions about them in your company's public filing — you cannot hide your head in the sand on this one.

So what kind of updating might your disclosure controls and procedures need? I cannot answer that question for you. For one thing, it's not my place — the answer depends on your company's specific facts and circumstances. For another thing, we don't possibly have enough time this evening to even scratch the surface. I would urge you all, however, to be actively involved in those updates and make sure you're satisfied with how they've been planned and how they're progressing. And make sure your team is thinking outside the box. Because of the new requirements in the executive compensation arena, you may need to include more people, different people who have never been involved in your public company disclosures in the past. You may need to set up new processes and circuits for gathering, compiling and analyzing information even before making disclosure determinations. Remember that the universe of people at the company for whom disclosures may be required has been expanded in many cases.

I am sorry I cannot provide you any definite or detailed answers but I would strongly urge each of you to make sure someone else does or, arguably even better, that you yourself are actively involved in coming up with these answers for your company. And please don't leave this task for another day. If it waits until the 11th hour, it is unlikely to get done right and it is unlikely to work effectively. You have a personal obligation under the securities laws as well as to your investors. Please plan ahead and if there is to be one take away for you from tonight, let this one be it. Get the processes and procedures going to your satisfaction — any compensation specialists, disclosure lawyers or other advisors you have should be on top of this — make sure they are and that you are as well.

Role of the Compensation Committee

I am sure that countless compensation consultants and other specialists have a wealth of advice about how our new rules will be changing the landscape for the compensation committee. I believe that's true in at least some respects, and I think it's an important topic. But speaking with all of you tonight, I would just like to look at one narrow slice of the compensation committee pie — specifically, how does the Compensation Committee's changing role under the new rules relate to all of you and more specifically to your certifications and to those disclosure controls and procedures we were just discussing.

I imagine many, if not all, of you are familiar with the old "Board Compensation Committee Report on Executive Compensation" that used to appear in the proxy statement. As its name suggests, that one was a report by the compensation committee — not the company or management, and you did not certify to it. That report, however, has now been eliminated and replaced in some measure by the new CD&A section. In addition, a new and very different Compensation Committee Report will also be required going forward which I will describe shortly.

Perhaps we should step back just for a moment and return to a point I alluded to when talking about the new CD&A — it is filed company disclosure. Among other things, that means that it will be covered by your required SOX 302 certification. In some ways, the CD&A covers the same ground the old board compensation committee report covered. To my mind, it also covers much more. It's also company disclosure, and you each are personally on the hook (through your certifications) for what it says. I can hear some of you saying, "How can that be fair?"

In response, I would make a couple of points. First of all, the CD&A really is company — not compensation committee — disclosure. Remember the analogy to MD&A — in this sense too, the two are in the same camp and they are part of your company's total disclosure. But to the extent the CD&A speaks to anything that you might feel you really can't assess the accuracy of, the Commission has mandated that the Compensation Committee supply a new report, which you will be able to look to as an important part of your process (your controls) of getting comfortable with the whole of your company's disclosure.

So if you'll allow me just a couple more minutes of your time, I would like to talk briefly about the new compensation committee report and how it relates to you. The Compensation Committee Report was modeled on the existing Audit Committee Report, and it must contain just 2 statements:

  1. whether the compensation committee has reviewed and discussed the Compensation Discussion and Analysis with management, and
  2. based on this review and discussions, whether the compensation committee recommended to the Board of Directors that the CD&A be included in the company's annual report on Form 10-K and proxy statement

The Compensation Committee Report will appear over the names of the compensation committee members and will be furnished, not filed — so even though it will be incorporated into your company's 10-K, your certification will not cover this report.

But this report, assuming your committee does recommend inclusion of the CD&A in your company's filings, should help you with the background and comfort you need in making your certifications. Similarly, if your company and your compensation committee do choose to engage in the review and discussions that the CD&A contemplates, I would think that should also help you as part of your disclosure controls and procedures. I should note that the SEC does not require those reviews and discussions (note the use of the word "whether" in the compensation committee report) but I imagine many companies will do so. I would also encourage all of you, individually, to think about what you feel you need and then to make sure you get it. Do you need the chairman of your compensation committee to be more involved, at an earlier stage? If you do, then I personally would urge you to try to get that started. In another speech I gave last week at the Practising Law Institute's Directors' Institute here in New York, I similarly urged directors, especially those serving on compensation committees, to have the same attitude and to understand what their companies, and their management, might need from them in light of the new rules.5 Don't sit idly by between now and the date your proxy (or even your 10-K) gets filed. Do whatever you need to be prepared.


In conclusion, I hope you are all convinced (if you weren't already) that the Commission's new executive compensation disclosure rules should be of fundamental interest to each of you individually. I acknowledged earlier the critical role you play to American business. And as I hope you know, you also play a critical role under the securities laws — for your shareholders and for investors more generally. The certifications you sign are one reason for this but those certifications are, to my mind, even more importantly a reflection of all the other, more fundamental reasons that you are so key to your investors. In other words, your certifications are important because of your substantive contributions and your importance to your company and because of all the insights and understandings you have that investors will never be able to fully share. You can, however — precisely because of your critical role and your authority at your company — help investors get a little closer to your insights and your understanding. Do what you can — what you and your colleagues in the executive suite are probably uniquely qualified to do — to make sure your company's disclosures are the best they can be. I know each of you is an incredibly busy person, but I think you will find that the rewards of doing this are more than worth the time and effort.

Understanding and pursuing the principles of the new executive compensation disclosure rules is one way you can do that. If you appreciate and embrace the importance of this disclosure (and after all, it includes disclosure about your compensation), I imagine that attitude might go a long way toward inspiring and enlisting the others around you to share your sincerity and your commitment to the cause. You can also advance the needs and interests of your shareholders by structuring your company's disclosure controls and procedures so that they are aligned with these new disclosure tasks. And I hope you also understand how doing so is in your own best interest and can help serve your own needs. It truly is a complete circle, and I am convinced that if all the players on the team share the same understandings and the same commitment to the same goals, then you, your company and your investors will all reap the benefits. Thank you again for your time this evening.



Modified: 10/06/2006