SEC's White speech on executive compensation

By Cydney Posner

At yesterday's Annual Executive Compensation Conference in New Orleans, SEC Director of Corp Fin, John White, delivered an address entitled "Executive Compensation Disclosure: Observations on Year Two and a Look Forward to the Changing Landscape for 2009."  White observes that the financial crisis has pushed executive compensation "back into the spotlight," with a recurring theme being public concern about the levels of executive compensation paid at Wall Street financial institutions as decisions were made that ultimately contributed to the crisis. Recognizing that most public companies are not financial institutions, White takes on the broader implications of this concern and poses this key question: "Would it be prudent for compensation committees, when establishing targets and creating incentives, not only to discuss how hard or how easy it is to meet the incentives, but also to consider the particular risks an executive might be incentivized to take to meet the target — with risk, in this case, being viewed in the context of the enterprise as a whole?" This important issue may well inform many compensation committee meetings this fall. Note that, to the extent these considerations are or become a material part of a company's compensation policies or decisions, a company would be required to discuss them as part of its CD&A.

White also encouraged companies, in drafting CD&A for the upcoming proxy season, to consider the impact of recent economic and financial events on the company's compensation program, including whether outstanding awards or plans have been modified, programs restructured, compensation elements re-weighted, performance conditions waived or new standards set. In addition, any changes in processes and procedures for determining executive and director pay would trigger disclosure under Item 407.

For 2009, Corp Fin intends to target its review of filings of all of the largest financial institutions (at least those still standing). At this point, that should give everyone a lot of comfort. With regard to the SEC's 2008 broad-based review, the compensation areas that received the most comment were, not surprisingly, (1) the need for more analysis, (2) disclosure of performance targets, and (3) disclosure relating to benchmarking.

Turning to the absence of analysis, White advocates, again, the "clean slate" approach to CD&A drafting. (Now there's some pragmatic advice.) The staff's comments have focused on the need to provide an "informative analytical discussion" of (1) the material elements of compensation, (2) how companies arrived at the varying levels of compensation, and (3) why they believe their compensation practices and decisions fit within their overall objectives and philosophy. In this regard, White reminds us to:

• "explain and place in context each of the specific factors considered when approving particular pieces of each named executive officers' compensation package;
• analyze the reasons why the company believes that the amounts paid are appropriate in light of the various factors it considered in making specific compensation decisions; and
• describe why or how determinations with respect to one element impacted other compensation decisions."

For example, companies should describe the extent to which actual results compared against minimum, target or maximum levels of performance goals, how those results led to specific payouts and/or how and why the exercise of discretion influenced the payout. Where individual performance is identified as a significant factor, companies should identify specific contributions and put those achievements in context to demonstrate qualitatively how they resulted in specific compensation decisions. Companies should also provide clear descriptions of the correlation among the various elements of compensation, including the extent to which compensation committees review each element individually or engage in a collective evaluation of all components of executive pay.

In connection with disclosure of performance targets, White cautions against making a "general result-oriented conclusion at the time of filing and then later, only after an inquiry from the staff, asking your lawyers to perform a competitive harm analysis….The staff has significant and substantive experience applying the analysis relating to the FOIA standard and we expect companies to substantiate a legitimate position rather than merely provide generalized support for a casual determination that some sort of harm might result from disclosure. Indeed, without making a reasonable determination that the company would suffer competitive harm, the company has no basis to omit the incentive target at the outset.

With respect to benchmarking, companies are expected to identify the companies in the peer group, disclose the basis for selecting the peer group and provide insight into the relationship between actual compensation and the data utilized in benchmarking or peer group studies. In many cases, this disclosure has been inadequate, according to White. The SEC has provided guidance distinguishing between data points used to base or frame a compensation decision (which would be considered a benchmark) and simple review or consideration of a broad-based third-party survey (which would not).