by
John W. White
Director, Division of Corporation Finance
U.S. Securities and Exchange Commission
Tackling Your 2008 Compensation Disclosures:
The 2nd Annual Proxy Disclosure Conference
San Francisco, California
October 9, 2007
Good afternoon. Thank you Jesse [Brill]. I am excited to return to San
Francisco to talk about executive compensation disclosure in the 2007 proxy
season — the first season under the new requirements the Commission adopted
just over a year ago. The staff’s observations on the first year disclosures
were published this morning, and what a great forum this is to reflect on
where we are in our pursuit of the “clearer and more complete picture of
compensation” that the Commission sought in adopting the new rules.
In the next half hour, I plan to share with you some of my views on where
the first-year disclosures have realized this goal and where they have not.
The positives are substantial — and there is a wealth of new information
available to investors for the first time. Investors have been provided with
the most comprehensive disclosure ever regarding how much public companies
pay their executives and directors. There are some very important areas,
however, where work remains for next year.
As I noted, these are my views — so let me go ahead and provide you the
required disclaimer — the views that 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 the Commission or its staff, other
than myself.
It was in this city, at this series of conferences, three years ago in
2004, that my predecessor Alan Beller started it all off with his memorable
“all means all” speech.1
We have come a long way since then — 382 pages of proposals,2
almost 30,000 comment letters,3
489 pages of adopting releases,4
112 interpretations,5 a
first full season of disclosures and, most recently, a staff report on the
first year disclosures after 350 reviews.6
On Alan’s “all means all” point, we have made great progress — the rules are
pretty clear on what compensation companies need to disclose, and what they
need to quantify. The new tables and footnotes, and what companies are
required to put in them, take us a long way toward our disclosure goals in
this area.
The Commission made clear in adopting the new rules, however, that it is
looking for more than just the value of the components of compensation and a
total value of compensation. What is that “more” it is looking for? In order
to provide investors with more than just tables of numbers, the Commission
created the new Compensation Discussion and Analysis requirement to “put
into perspective for investors the numbers and narrative that follow it.”
This “overview” is very much a principles-based requirement, like the MD&A
section with which we are all so familiar. In an instruction to the CD&A
requirement, the Commission made clear that CD&A “should focus on the
material principles underlying the registrant’s executive compensation
policies and decisions and the most important factors relevant to the
analysis of those policies and decisions.” My emphasis on the word
“analysis” should provide you with a pretty good idea of the principal place
where I believe many companies came up short — where disclosure can be
improved. More on that in just a moment.
Let’s turn to the Division’s report, which was published this morning.
Our report largely provides an overview of our principal areas of comment.
Rather than waiting to reflect the give and take of the individual company
comment process, we have published our observations as soon as initial
comments were issued to all the companies. One observation: these comments
reflect places where we believe companies may need to provide additional or
clearer disclosure in future filings. That’s the very nature of the comment
process. But we should not lose sight of the fact that implementing the new
disclosure requirements, gathering the new information, and crafting the new
disclosures for investors, often writing on a clean slate, was a substantial
task in the first year. As a whole, company efforts were quite admirable,
and investors are well-served by the new disclosures.
Principles-Based Disclosure and
Materiality
For context, let me briefly go back to the principles-based regime of
CD&A, to the role of examples, and to materiality. Last year as we headed
into the first season, I made a series of remarks based on the idea that, in
drafting first-year CD&As, companies needed to focus on using the
principles-based regime outlined in the adopting release — because,
“principles matter.”7
That certainly remains the case, and “principles still matter.”
Recall how principles-based disclosure works. There are overarching
disclosure principles — and the Commission laid those out in the release and
the rules. You’ve heard them and read them. And then there are examples —
and the Commission provided 15 of them. These examples are just that. They
neither encompass the universe of possible required disclosures, nor are
they mandatory. Companies need not discuss each example, as disclosure is
required only where material. The instructions to the CD&A provide a pretty
clear mandate in this regard. Let me repeat what I just said. Disclosure is
required only where material.
Analysis
Now, back to our comments. Several key themes recur in our comments, one
of which I want to lay out a bit more bluntly than in the report. And these
are my views of course.
Far too often, meaningful analysis is missing — this is the biggest
shortcoming of the first-year disclosures. Stated simply — Where’s the
analysis?
I know no better way to emphasize this than to go to the very examples
that the staff highlighted in the report. A good starting point, and a
representative example, is disclosure of compensation philosophies and
decision-making processes. We saw a great deal of detail this year, but what
was missing was a discussion of how and why those philosophies
and processes resulted in the numbers the company presented in its tabular
disclosure. There also was a great deal of detail on individual compensation
components, but little discussion of how the amounts paid or awarded under
each compensation element — and how the total compensation delivered from
all these elements (what some refer to as wealth accumulation) — affected
the decisions that companies made regarding amounts paid or awarded under
other compensation elements. That’s missing analysis.
A few more examples where analysis was missing include disclosures with
respect to benchmarks, differences in compensation policies and decisions
among executive officers, and change-in-control arrangements. I don’t plan
to go through these today — they are discussed in the report if you’d like
more detail. I will instead take you through one additional example —
performance targets. I’m spending a bit of extra time on this area for a
couple reasons. It was one of the most commented on areas in the first-year
disclosures and it also brings together not only the missing analysis theme,
but also the concepts of principles and materiality as the foundation for
your disclosure decisions.
As we all know, and as I just noted, the new rules include 15 examples of
items that may be material elements of a company’s compensation policies and
decisions, and therefore require CD&A disclosure. Two of these examples go
to what items of corporate performance are used in setting compensation and
how they are used. Discussion of performance targets comes up in the context
of these examples.
In reviewing the first year disclosures on performance targets, we were
disappointed to find that, though a significant number of companies
apparently use performance goals or targets, far too often an analysis of
how the targets were used in setting compensation was missing. In our
comment process, we approached these disclosures from the starting point of
materiality — as we all know, the CD&A rules require disclosure with respect
to an example only where material. So, just to say it another way, depending
on whether the CD&A examples that relate to corporate performance are
material for your company, performance targets are a disclosure point that
may or may not need to be addressed.
What did we ask for? You guessed it — for more analysis. We often found
it difficult to understand how companies used targets or considered
qualitative individual performance to set compensation and make decisions.
Our comments were not intended to suggest that every CD&A must necessarily
address disclosure regarding targets for the year in question, or any other
year. In the first instance, a company needs to determine whether use of
corporate performance items is material, and for which years, and to address
disclosure and confidentiality accordingly. Where targets appeared to be
material based on what was disclosed, but the company did not disclose
specific targets, we asked that the company either disclose the targets or
demonstrate why doing so would cause competitive harm. In those instances
where a target is properly omitted based on the competitive harm standard,
the company must discuss, in a meaningful way, how difficult it will be for
the executive or how likely it will be for the company to achieve that
target.
Just to expand briefly on one last related point — my references to the
years for which disclosure must be addressed. This takes us back to
principles (as well as to an instruction in the rules).8
As we know, CD&A must cover the last fiscal year, but depending on
materiality, there are a number of situations where a company may also find
it necessary to discuss targets for either prior years, the current year, or
later years, to place their disclosure in context or “affect a fair
understanding” of a named executive officer’s compensation. This might occur
with a multi-year compensation plan or where targets varied materially from
year-to-year.
So, I hope that gives perspective on where many of our comments fell
regarding analysis. In looking at disclosures and staff comment letters on
those disclosures, you certainly can come up with more. But I think that if
you look at the areas I’ve mentioned, you will understand where the Division
feels companies can improve their analysis in the coming proxy season.
Presentation
With that, I’m going to take you briefly through a second key area of our
comments on the first-year disclosures — manner of presentation. Put simply,
“presentation matters.” The revised rules require companies to disclose a
great deal of information — and that information goes to the heart of how it
compensates its executive officers. How a company provides that information
is, in many ways, as important as its content.
Manner of presentation is not limited to plain English principles,
although our requests for clearer and more understandable disclosure
constitute a significant portion of our comments in this area. The
Commission specifically affirmed its support for plain English principles in
the adopting release for the new rules, noting that “[c]learer, more concise
presentation of executive and director compensation … can facilitate more
informed investing and voting decisions in the face of complex information
about these important areas.” And I think that we can all agree that with
executive compensation we often are dealing with complex information.
Chairman Cox, who is particularly focused on the importance of clear,
concise, and understandable disclosure in all Commission initiatives, will
be speaking later this week on plain English principles at a symposium on
plain language in Washington DC,9
so I am going to leave the real message on manner of presentation for him.
But I will mention a couple things I’d like you to focus on.
Disclosure can fail in either of two different ways — it can be presented
clearly and understandably without being meaningful or responsive to
disclosure requirements or, conversely, it can be responsive in content
without being clear and understandable. The first of these failures takes us
back to analysis. Although companies generally appear to have made a good
faith effort to provide clear and understandable disclosure, we found that
many omitted critical information — largely the “how” and “why” of their
executive compensation decisions. This is where we asked for enhanced
disclosure most often. Where we ask companies to add or enhance their
analysis, this does not mean that we are trying to undermine efforts at
plain English-compliant disclosure. Our requests for improved analysis need
not lengthen disclosure. Rather, with careful drafting, I believe companies
can achieve a succinct and effective discussion that provides the required
disclosure and embraces plain English principles.
In this regard, I refer you to the Division’s report, where we have
described a few of the ways we have suggested companies can improve the
content of their disclosure without compromising plain English principles.
Where companies include boilerplate discussions of individual performance,
they should instead provide specific analysis of how they considered and
used individual performance to determine each individual’s compensation.
Where a company has simply repeated in its CD&A information that it also
presents in the required compensation tables, it should replace the
redundant disclosure with a clear and concise analysis of that information.
Where disclosure has been (or appears to have been) lifted directly from the
technical language of a compensation plan or employment agreement, the
company should redraft that disclosure in a more clear, concise, and
understandable manner.
I think that if companies and their disclosure counsel embrace this
guidance, and make changes consistent with the spirit of the guidance, it
will quickly become apparent that you can be responsive to both staff
requests for additional analysis and the plain English requirements.
One final thought in this area, one that intersects both the topics of
presentation and analysis, and that appears in the report in our discussion
of performance targets. We have heard concerns expressed by company
executives and disclosure counsel that the staff, in its comment process,
may be asking for quantitative explanations of decisions that may in fact be
subjective assessments of individual performance. Let me assure you — that
is not our intent. We are simply asking these companies to present how these
decisions were made — as the report phrases it, “to clearly lay out the way
that qualitative inputs are ultimately translated into objective pay
determinations.” In talking to company executives and disclosure counsel in
the past couple of months, we frequently have been provided with very clear,
straightforward explanations of this. That is exactly what we are looking
for — in the filing.
Second Year Disclosure
After all that, I know that many will now say, “Show us the good
examples.” However, even with my disclaimer, I feel constrained from
highlighting individual company disclosures — good or bad. I also don’t want
to see everyone coming back with identical boilerplate disclosure next year.
But I will say, there are good disclosures out there — they will be
discussed at this and other conferences I’m sure — and I would challenge you
all to consider those examples as you draft disclosure tailored to reflect
the individual circumstances of your company, and next year to aspire to
become one of those examples — if you are not one already. Don’t let this
coming year’s disclosures be just a mark-up of the first year. Instead step
back and ask some very important questions.
- What is material to my shareholders, to my investors, as they examine
the compensation of our executives and make their voting decisions for our
board of directors and investment decisions with respect to our company?
- What are the material elements of individual executive and corporate
performance that are considered in setting executive compensation?
- What is the relationship between the objectives of our compensation
program and the different elements of compensation?
- What are the material factors that relate to our compensation
decision-making process?
Then, sit down and focus on two very important aspects of your
disclosure:
Analysis. Focus on how and why you
reached the compensation decisions you made in your CD&A. Don’t provide a
laundry list of facts. Discuss and analyze the elements of your
decision-making. Some have suggested that the way to ensure proper emphasis
of analysis is to require companies to provide a separate section titled
“Analysis” in the CD&A. This suggestion is one of many good ideas. I will
leave it to you, however, to determine how best to highlight the analysis.
Presentation matters. Focus on being clear, concise
and understandable. Our rules require you to provide substantial amounts of
information. Consider ways to present your information in a manner that
helps people understand it. Consider presenting layered disclosure. Consider
using tables and charts to present complex information. Continue your
innovative efforts to use these tools to illustrate the relationship between
compensation objectives and different forms of pay.
So, going forward, the question becomes — where do you, and we at the
SEC, fit into this process?
Disclosure Counsel. Let’s start with you — disclosure
counsel and other advisors. What is your role in improving second-year
disclosures? Alan Beller said it in 2004, I’ve said it in the past, and I
will keep saying it. You must not lose sight of who your client is — the
company. Not the CEO. Not the CFO. Not any other member of management. And,
not the board. It is troublesome, to say the least, when I hear the
suggestion that some have lost sight of their role in this very sensitive
area. Executive compensation disclosure must be guided by counsel acting for
the company. The information the company’s shareholders seek and need should
guide your disclosure advice, and the company’s disclosure decisions. A
company’s shareholders want to see what executive compensation decisions a
company makes and how it makes them. That is your audience. That is your
client.
SEC Staff. Those of us on the SEC staff, where do we
fit in? In our future reviews of executive compensation disclosures, we will
have the benefit of what we learned and continue to learn in the first year.
We will certainly expect to see the results of our call for more and better
analysis and clearer, more concise disclosure. In issuing comments this
year, we realized that each company was faced with an entirely new
disclosure regime for executive compensation. We took into account each
company’s learning curve. We issued a lot of comments in which we asked
companies to revise their future disclosure, not their current disclosure.
We asked a lot of questions so we could better understand why companies made
the disclosure they did.
As we enter the second season, we will expect companies to
have taken our guidance to heart, and I anticipate that you will see that
heightened expectation reflected in the type and focus of our comments and
reactions next year.
With that, I want to close with one thought, which is really quite
simple, and you have no doubt heard it before — step back next year and
start with a clean slate, a blank sheet of paper. Now when I listen to that,
it sounds like pretty dull jargon — a nice platitude. You’ll no doubt nod,
and then go on.
So let me try a simple, more practical suggestion. One that perhaps will
show up in those lists of practice points many of you develop.
This fall. Before anyone starts drafting your CD&A. Ask every key
participant (from the compensation committee chair on down) to turn in one
page — no more than a page — perhaps even with the caption “Analysis.” Hand
them a copy of our just-issued staff report so that they see our concerns
about missing analysis. Then ask for bullets. Those bullets should reflect
what he or she sees, from their perspective, as the key “hows” and “whys,”
including, as appropriate
- the key analytic tools used by the compensation committee,
- the findings that emerged from the analysis, and
- the resulting actions taken impacting executive compensation in the
last year.
In short, the key points of analysis. The next step for the drafting
team is obvious. Call this process collecting the “clean slate” lists.
Consider building it into your procedures. Follow up on getting the lists.
So, that’s it. Thank you for inviting me, and I look forward to seeing
your disclosures next year.
