By now, most publicly traded companies have completed their 2008 stockholder meetings. This was the second year of working with the SEC's new compensation disclosure rules, including the new section of the proxy on Compensation Discussion & Analysis (CD&A). A review of lessons learned over the past two years of working with the new rules may provide some useful insight for the future.

Several Cooks in the Kitchen

One must do more than simply look to the SEC for guidance on compensation disclosure. The new rules were intended to give shareholders a single source of compensation information that would fully disclose all numbers to stockholders in an "apples-to-apples" comparison. A laudable goal, but companies have to consider a multitude of regulators, quasi-regulators and watchdogs to get there. This requires a balancing and blending of the following considerations:

  • Compensation calculations for executive officers that are derived from financial statement disclosures dictated by the Financial Accounting Standards Board (especially FAS 123R), IRS 280G golden parachute tax regulations for change in control payments, and the overlay of SEC disclosure rules that sometimes appear to include (but are not limited to) FASB and Internal Revenue Code disclosures.

  • IRS regulations, particularly 162(m) standards for disclosing performance based compensation.

  • In particular, companies must either disclose performance information that could be helpful to competition, or explain why the performance information was not disclosed.

  • Proxy review standards adopted by Risk Metrics (Institutional Shareholder Services) and other proxy review services. Risk Metrics seems to have tightened its standards for approving new shares in equity compensation plans. By the way, Risk Metrics has occasionally recommend a "no" vote on a proxy proposal, even after it had been hired by the issuer to review and pre-approve the proposal.

  • Shareholder activists - several well-known groups (such as CalPERS) actively promote and base proxy voting on adoption of compensation standards.

  • Evolving standards of board governance for elements of executive pay.

The Good News: Quality of Disclosure, Not Compensation Philosophy

It seems that the bright spot is the lack of SEC enforcement on compensation philosophy. That task has so far been left to others, such as Risk Metrics and the activist shareholders. (For more information, see Waller Lansden's Executive Compensation blog at this link.) These groups tout phrases like "pay for performance" and "say on pay." Recent IRS rulings indicate that pay for poor performance is now suspect and tax deductibility is at risk (see Waller Lansden's Executive Compensation blog). These organizations and regulators are actively engaged in the debate on appropriate standards for executive pay. In addition, this issue is creating sound bites this election cycle.

It appears that the SEC may be staying out of the battle over compensation philosophy. Instead, the SEC seems to be focused on the quality of a company's disclosure. This quote appears on the SEC Division of Corporate Finance website:

The Division views the comment process as a dialogue with a company about its disclosure. The Division's comments are in response to a company's disclosure and other public information and are based on the Staff's understanding of that company's facts and circumstances.

In other words, the SEC is not telling companies that their CEO pay is too high, too low, or just right. In responding to SEC proxy comments, we have found that the SEC wants to see a link in the proxy between the stated compensation philosophy (formerly known as the "boilerplate") to the amounts that were actually paid. For example, if a company claims to pay at a certain competitive benchmark

(e.g., 50th percentile), the SEC will require proxy disclosure of the companies included in the benchmark and how it was chosen. This probably isn't required for companies that do not tie pay to a benchmark. Similarly, disclosing that the company believes in "competitive" pay isn't an adequate explanation. Instead, the SEC expects the proxy to include a discussion of how "competitive" pay was determined and how that translated into actual pay.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.