SEC Finds More Clarity Needed in Executive Comp Disclosures

October 10, 2007 ( - The Securities and Exchange Commission (SEC) has told companies they need to focus in their regulatory disclosures more on how and why they arrive at executive compensation decisions and policies and to use plain English when they do.

The SEC made the assertion In its report on its review of the executive compensation and other related disclosure of 350 public companies to evaluate compliance with and provide guidance on revised disclosure rules.

In its report, the SEC pointed out the new regulations require a company to provide “clear, concise, and understandable disclosure of all plan and non-plan compensation . . . .” The agency said that in a number of instances, it suggested companies could improve their disclosure 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.

The report said companies made a good faith effort to provide clear and understandable disclosure, but fell short of full compliance with the underlying disclosure requirements. Where the SEC asked a company to add to or enhance its analysis, the agency said it did not necessarily think the disclosure should be lengthened. “Rather, careful drafting consistent with plain English principles could result in a shorter, more concise and effective discussion that complies with our rules,” the report said.

While the SEC said disclosure will always depend upon each company’s facts and circumstances, it advised there are situations where a company may find it necessary to discuss prior and current year performance targets to place its disclosure in context or achieve a fair understanding of a named executive officer’s compensation. It also may be material for a company to disclose whether it or the named executive officer achieved targets in prior years, the report said. Those situations may include where a company has a multiple-year compensation plan or where target levels vary materially between years.

More comments were issued regarding performance targets than any other disclosure topic in the review. The SEC said it 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. The commission pointed out it does not “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.”

The commission said it did not detect any common themes in its reviews of the required named executive officer and director compensation tables, the footnotes to the tables, or the narratives that followed them. Overall, relatively few comments were issued to companies on this area of their disclosure.

In a significant percentage of the filings reviewed, the SEC suggested companies should consider making some items of their disclosure more prominent. The commission explained it has often found that where a company emphasizes material information and de-emphasizes less important information, investor understanding of the company's disclosure is improved.

Where a company provided a lengthy discussion about its compensation philosophies, the SEC suggested 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 decisionmaking process, the commission suggested that, rather than explaining the process, the company should explain how its analysis of relevant information resulted in the decisions it made.

The agency also 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, the report said.

In the instances where it appeared that performance targets were material to a company's policy and decisionmaking processes and the company did not disclose those targets, the SEC asked it to disclose the targets or demonstrate that disclosure of the particular targets could cause it competitive harm.

Where a company presented a non-GAAP (Generally Accepted Accounting Principles) financial figure as a performance target and the company did not disclose how it would calculate that figure, the commission asked it to disclose how it would do so. As an example, the report said in the instance a company disclosed total shareholder return as a performance target, the SEC asked the company to disclose how it would calculate total shareholder return and describe how it would influence compensation decisions.

Where a company stated it used comparative compensation information, but retained discretion on how to use it, the SEC asked it to provide appropriate disclosure. For example, the report said, if a company said it benchmarked its compensation, but it retained discretion to benchmark to a different point or range, or to not benchmark at all, the commission asked it to disclose the nature and extent of that discretion and whether or how it exercised that discretion.

Where a company indicated it benchmarked compensation to its peers, but did not identify the peers or provide sufficient details concerning the benchmarking it used, the SEC asked it to identify the companies to which it compared itself as well as the compensation components it used in that comparison.

The agency said it 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. It 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 and also asked companies to discuss how potential payments and benefits under these arrangements may have influenced their decisions regarding other compensation elements.

Finally, where a company's disclosure was unclear about who made the compensation decisions, the SEC asked for clarification. Where a company indicated its principal executive officer had a role in the compensation decisionmaking process, it was asked to describe his or her role.

Item 407(e)(3)(iii) of the regulations requires companies to disclose the role compensation consultants play in the decisionmaking process, and the SEC asked a number of companies to do so. In particular, companies were asked to more specifically disclose the nature and scope of a consultant's assignment and material instructions the company gave the consultant.

The report, Staff Observations in the Review of Executive Compensation Disclosure, is here .