In the 2007 proxy season the Securities and Exchange Commission (the "SEC" or "Staff") required substantial revisions with respect to the manner in which public companies report their executive compensation practices to shareholders. The new "principles-based" rules (the "SEC rules") significantly expanded the tabular disclosure requirements for compensation paid to certain "named executives" and mandated the new Compensation Discussion & Analysis ("CD&A") requirement, which represents management's account of the processes and methodologies for setting executive compensation, the rationale for adopting certain programs, and the particulars with regard to incentive compensation.

Last month the Staff issued comment letters ("Letters") to a substantial number of companies. These Letters are the first phase of a three-phase SEC review project to determine how well compensation disclosures have complied with the SEC rules and to provide guidance for improving compliance in future years. However, the first round of comments does not provide significant insight into what is needed for compliance but rather does nothing more than restate the requirements already published in the SEC rules. In the second phase of the project the Staff is expected to report the overall findings of their review, taking into account the responses by the companies to the Letters. This report is expected to be issued in late fall of this year. It is expected that the third phase of the project will involve amendments to the SEC rules, but is not expected to happen until summer of 2008.

The subjective nature and ambiguity of the CD&A requirements make it difficult for the Staff to ascertain whether reporting companies have complied with the SEC rules. This is why the Letters have not been specifically tailored to a particular company's disclosures. In addition, most of the Staff's comments have been issued as "future filing" comments that do not require amendments to previous disclosures, but instead allow companies to revise their disclosures prospectively.

The Letters that have been issued thus far are primarily aimed at the disclosures included in the CD&A, with a few directed at the narrative sections supporting the executive compensation tables. Summarized below is a sample of the more common items appearing in the Staff's Letters:

  • Provide more specifics as to how performance impacts compensation payouts
  • Describe the role of the Compensation Committee in setting compensation
  • Provide more details regarding the qualitative and quantitative aspects of performance goals in incentive plans (e.g., disclosure of performance targets)
  • Provide more information as to the determination of benefit levels with respect to the various circumstances that trigger payments upon termination and change-in-control arrangements
  • Provide more explanation regarding the rationale for the various elements of the compensation mix
  • Provide more disclosure on the role of and services of compensation consultants, including those retained by the Compensation Committee and management
  • Explain major disparity of pay levels or opportunities among the named executives
  • Identify companies in any peer group used for benchmarking purposes
  • Provide definitions for "good reason," "change in control" and other undefined terms
  • Provide more detail regarding the process and timing of equity grants
  • Provide more information regarding the content of tally sheets and how the information is used in setting compensation levels
  • Describe management's role in setting compensation, including that of the CEO
  • Provide the rationale behind the terms in executive employment agreements
  • Describe the processes used to determine director compensation

The above comments do little to clarify what the Staff is looking for over and above what is already stated in the SEC rules. The SEC allows companies to exclude certain items if disclosure of such information would result in competitive harm. While companies are not required to formally request confidential treatment from the SEC to omit disclosure, companies should consult with their legal counsel to determine whether such omission is appropriate and what is needed to justify the omission. In view of the ambiguity associated with the SEC rules and lack of specificity in the Staff's Letters, it is not too early to begin the process of gathering information to determine the appropriate disclosures for 2008.

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