Public companies and their securities counsel should take the time now to absorb the lessons learned from the 2007 proxy season and begin the implementation process of action items for the 2008 proxy season. During the 2007 proxy season, public companies were required to disclose executive compensation under far-reaching new executive compensation rules which modified significantly the executive compensation tables and required a new Compensation Disclosure and Analysis ("CD&A") report. The Securities and Exchange Commission (the "SEC") has indicated that while the first year of executive compensation disclosures under the new disclosure regime has yielded examples of good, understandable and responsive disclosure, it has also resulted in executive compensation disclosures that missed the mark in several respects.
There have been three important SEC developments that have resulted from the 2007 proxy season: (1) the SEC's review of the executive compensation disclosures of 350 public companies; (2) the SEC's Report released on October 9, 2007 titled "Staff Observations in the Review of Executive Compensation Disclosure," and (3) the speech by John White, Director of the SEC's Division of Corporation Finance, on October 9, 2007, titled "Where's the Analysis?".Directors, executive officers, and securities counsel for public companies should carefully review the results of these SEC developments, evaluate the strengths and weaknesses of their own 2007 executive compensation disclosure based on these SEC developments, and begin the process of improving upon their executive compensation disclosure for the 2008 proxy season. This is not simply a lofty goal, but imperative as the SEC has indicated that it will be approaching the second year of executive compensation disclosure with higher standards and expectations - there will be no more passes in the 2008 proxy season.
This article summarizes certain of the important lessons learned from the 2007 proxy season and offers suggestions regarding action items for the 2008 proxy season.
Lessons LearnedFrom The 2007 Proxy Season
The SEC's Report and White's speech illustrate the lessons we should learn from the 2007 executive compensation disclosure shortcomings in "Analysis" and "Presentation."
Analysis : Directors, executive officers and securities counsel for public companies should re-evaluate, in light of the SEC developments discussed above, whether their company's 2007 CD&A contained sufficient meaningful analysis. According to White, meaningful analysis should be focused on addressing the "hows" and "whys" of executive compensation decisions. The re-evaluation of the company's 2007 executive compensation disclosure should carefully examine the following areas where the SEC expressed its concerns over the lack of analysis:
• Compensation Philosophies and Objectives - how and why did these compensation philosophies and objectives result in the specific amounts of compensation paid;
• Decision-Making Process - how did this process, including the analysis of information, result in the actual compensation paid;
• Compensation Elements - how did amounts paid under one compensation element affect decisions regarding amounts paid under other compensation elements and total compensation;
• Different Policies for Individual Named Executive Officers ("NEOs") - why are there policies in place or decisions made regarding individual NEO compensation that are materially different for individual NEOs and how are such policies and decisions materially different;
• Benchmarks - why and how were benchmarking to a peer group or other market comparison data utilized, including tying any compensation elements to a certain percentile of the comparative data, and what was the nature and extent of any discretion retained to benchmark to different percentiles or ranges, or to elect not to benchmark at all;
• Performance Targets - what was the process utilized to select company or individual performance targets, what was the criteria utilized to evaluate each NEO's performance if there was a subjective evaluation component, how did an evaluation of the performance targets translate into an objective compensation determination, and what was the nature and extent of any discretion retained to award compensation notwithstanding a failure to meet performance targets; and
• Termination and Change-in-Control Arrangements - why were the material terms of the company's termination and change-in-control arrangements structured in such manner and how did potential payments and benefits under such arrangements affect decisions regarding other compensation elements.
Presentation: Directors, executive officers, and securities counsel for public companies should take the SEC's words that "presentation matters" to heart and re-evaluate whether their company's 2007 executive compensation disclosure was presented properly, with a careful examination of the following areas:
• Plain English - were the company's executive compensation disclosures clear, concise and understandable, with material information disclosed more prominently than less material information, and analysis emphasized over lengthy disclosure onprogram mechanics;
• Format - did the company place its CD&A prior to the required compensation tables and did the company provide supplemental tables, charts and graphs that enhanced an overall understanding of the disclosure; and
• Boilerplate - did the company avoid boilerplate disclosure, particularly with respect to disclosure of compensation objectives and policies, discussions of executive officer performance and where performance targets were not disclosed, discussions of the degree of difficulty associated with achieving the performance targets.
2008 Proxy Season
"Clean Slate" Lists
A good starting point for a company's 2008 executive compensation disclosure is to follow White's suggestion and ask each key participant in the compensation setting process (i.e., the compensation committee members) to prepare a one-page "clean slate" list of bullet points reflecting what he/she sees from his/her perspective as the key "hows" and "whys" of executive compensation decisions, including how the company arrived at particular levels and forms of compensation and why it paid that level of compensation for each component of compensation.In order to provide a frame of reference to guide the compensation committee in drafting their "clean slate" lists, counsel or management should ask the compensation committee to answer the following questions which White posed in his speech:
• What is material to investors as they examine executive compensation and make their investment and voting decisions?
• What are the material elements of company and individual executive performance that are considered in setting executive compensation?
• What is the relationship between the company's compensation objectives and the different elements of compensation?
• What are the material factors that relate to the compensation decision-making process?
Additionally, White suggested that these "clean slate" lists address the compensation committee's key analytic tools, their findings, and the resulting executive compensation actions taken in the last year.These "clean slate" lists should then be compiled and discussed over the course of several meetings as a starting point for the 2008 CD&A. Key analytic tools utilized by the compensation committee will include such things as compensation consultant reports, tally sheets, internal pay equity analysis and accumulated wealth analysis.
The following are some suggestions for action items to implement during the 2008 proxy season:
CD&A - Analysis
• Evaluate whether the appropriate level of disclosure controls and procedures are in place in order to capture the "hows" and "whys" of executive compensation decisions.
• Evaluate whether the compensation committee has the right analytic tools at its disposal for its compensation setting process.
• Make sure the disclosure adequately explains the roles of compensation consultants and management in the compensation setting process, clearly identifies the mix of compensation (i.e., cash, options, stock awards, etc.) and why that specific mix was selected, and describes all relevant aspects of the CEO's compensation, including material differences compared to other NEOs, the CEO performance targets, actual CEO performance and how this translates into the actual amount of compensation paid to the CEO.
CD&A - Disclosure of PerformanceTargets
• Assess whether the company has sufficiently strong arguments to support the decision not to disclose performance targets on the basis that such disclosure would be competitively harmful.
• Based on the SEC's displeasure regarding boilerplate disclosure on the degree of difficulty associated with attaining the performance targets, consider disclosing how often similar performance targets have been attained historically.
CD&A - Format
• Consider whether adding a separately captioned section titled, "Analysis" as part of the CD&A or other headings and subheadings would help the overall presentation and readability of the CD&A.
• Consider adding an Executive Summary section to the CD&A.
• When considering adding any supplemental compensation tables, make sure the supplemental compensation tables are not given greater prominence than the required compensation tables and that the differences between the tables are adequately explained.
• Additionally, review the text provided immediately preceding the tables or consider adding text immediately preceding the tables that provides helpful information in interpreting the data in the table (i.e., such as any accounting concepts necessary to understand the numbers).
• Make sure that the font size and type used within the compensation tables and accompanying footnotes are appropriate.
• Consider, discuss and re-evaluate the appropriateness of certain compensation practices based on the individual circumstances of the company, including:
the purpose of pension plans and SERPs;
the company's cash severance arrangements, including the need for any cash severance arrangements at all or the desirability for such cash severance arrangements to have sunset provisions in light of an executive officer's wealth as calculated under an accumulated wealth analysis;
the need to grant equity awards to executive officers that already have a sizeable interest as calculated under an accumulated wealth analysis;
the need or desirability to continue providing perquisites; and
the implementation of a requirement that executive officers hold onto options and restricted stock until retirement.
In summary, heed the SEC's advice and warnings and implement a strategy for your 2008 executive compensation disclosure.
Esther L. Moreno is a partner in the Miami office of Holland & Knight LLP, where she practices in the firm's Public Companies &Securities Group. She has extensive experience representing both public and private companies in securities matters, corporate governance, mergers and acquisitions and general corporate law matters. Esther may be reached at (305) 789-7442.