Complying with the SEC's Compensation Discussion and Analysis Requirements

CPA Journal, The, Sep 2008 by Grant, Gerry

The latest SEC regulation focusing on executive compensation, the Executive Compensation and Related Person Disclosure amendment to Regulation S-K, aims to improve shareholder governance by providing a more complete and transparent view of executive compensation (sec.gov/rules/final/2006/33-8732a.pdf).

The new rule requires a company to provide extensive disclosure information about compensation for its most highly paid officers, including the chief executive officer, the chief financial officer, and directors. These compensation amounts must be summarized in an easy-to-read table that includes a total compensation column. All explanations are required to be in "plain English." The new rule also amends the disclosure requirements for stock options and updates the related-person transaction disclosure. Additional corporate governance disclosures related to executive compensation are also required. This new rule represents a significant change from prior disclosure requirements for public companies.

Disclosure Goals

The intent of the rule is not to increase the amount of information disclosed, but to provide a clear and complete analysis of executive compensation in a single location. The Compensation Discussion and Analysis (CD&A) and proxy disclosure requirement must include salary and bonus awards, as well as stock option grants, stock appreciation rights, long-term incentive plan awards, pension plans, and perquisites, like the personal use of corporate aircraft. The rule is required for all proxy statements and annual reports filed on or after December 15, 2006. The SEC completed its first-year review of 350 companies reporting under the new rule (www.sec.gov/divisions/corpfin/guidance/execcompdisclosure.htm). The sample targeted larger public companies from a variety of industries.

Overall, the SEC found that most companies improved disclosures on executive compensation and provided stakeholders with more information than ever before. Nevertheless, the SEC staff issued comment letters to the many of the companies they reviewed, asking for additional information about executive compensation packages. The sec has noted that in some instances, companies were asked to revise disclosure; in other cases, companies were asked to enhance disclosure in future filings.

The SEC's observations of first-year reviews are provided to help companies as they prepare for their second year of compliance. Smaller companies, in particular, may benefit from the comments the sec made to larger companies. Many of the sec's observations fall into two broad categories: the substance of the disclosures or the presentation of the disclosures. Although the comment letters deal with company-specific issues, there are general trends that emerged in the first-year compliance period.

The SEC staff found several areas where companies can improve their CD&A disclosures. The following suggestions to improve executive compensation disclosures are summarized from the reviews made by the SEC staff.

General Suggestions to Improve Compensation Disclosures

Do:

* Focus on how and why the analysis led to the levels of compensation.

* Include discussions about how one element of the compensation package relates to other elements of the compensation package.

* Identify material differences that exist in compensation policies between individuals.

* Discuss similar policies and decisions used for different individuals as a group.

* When discussing change-in-control and termination agreements:

* Explain how and why the material terms were structured.

* Discuss how these potential payments influenced other compensation decisions.

* When discussing stock options:

* Disclose all assumptions in the footnotes to the table.

* Disclose vesting dates, number of shares of stock, and equity incentive plan awards held by individuals at fiscal yearend in the footnotes.

Don't:

* Provide lengthy compensation philosophies-focus, instead, on how the philosophy resulted in the compensation paid.

* Include lengthy discussions about the decision-making process-simply explain how relevant information influenced compensation decisions.

Improving Disclosures Related to Performance Targets

Do:

* Include all specific corporate and individual performance targets used to set compensation policies.

* Detail how performance levels are determined.

* Discuss why the compensation was paid.

* Disclose the difficulty of achieving targeted performance levels.

* Disclose how the figure is calculated when using a non-GAAP performance measure.

* Include the names and industries of peer companies used as benchmarks.

* If disclosing performance targets could cause competitive harm:

* Demonstrate the rationale for this determination.

* Consider alternate methods to indicate the impact.

Don't:

* Attempt to defend a position or try to justify the compensation paid-simply discuss the qualitative aspects of performance targets.

* Use vague or broad data ranges for performance targets.

Improving Presentation of Disclosure

Do:

* Display required information more prominently than supplementary information.