In Focus

SEC Official Reviews Compensation Disclosure Expectations

SEC Deputy Director Shelley Parratt urged companies not to wait for staff comments to improve their compensation discussion and analysis ("CD&A"). After three years of comments on how to improve their disclosure, Parratt said companies now should be prepared to amend their filings if they do not materially comply with the rules. Parratt reviewed the 2009 proxy season and the staff's expectations for 2010 at a recent proxy disclosure conference in San Francisco.

Since former Corporation Finance Director John White in 2007 encouraged companies to start with a clean slate in drafting their CD&A, Parratt said the staff has continued to issue comments on specific disclosure issues, report on comment letter themes and provide disclosure guidance in its compliance and disclosure interpretations. At the end of the 2009 proxy season, the staff reviewed its comments and issuers' disclosure to look for common themes and for consistency in the staff's responses.

Parratt said the staff was pretty consistent in its comments on executive compensation disclosure. Companies which had previously been reviewed continued to provide enhanced disclosure, she said, so in many instances, they did not receive many comments. Companies that had not been reviewed received a substantial number of comments on the common themes the staff has publicized since 2007.

The staff believes that companies have a general understanding of the rules but are reluctant to apply them until they have received comments requesting the enhanced disclosure. They have tended not to disclose detailed compensation information or to prepare a rigorous analytical discussion about compensation practices until the staff asks them to do so in a review. Parratt urged companies to take a proactive approach to improve their CD&A disclosure rather than wait for a staff comment.

Parratt stressed the analysis part of CD&A. With the current focus on executive compensation, she said there is no better time for companies to improve their disclosure. Many investors have complained about boilerplate language and the length of CD&A, she added. Parratt recommended that companies see if there is unnecessary background or process-oriented information that can be omitted.

Public companies faced a number of compensation challenges in 2009. Parratt said the staff has seen instances where performance targets were not met so bonuses were not awarded. The staff has also seen instances where boards ignored performance targets and awarded bonuses at their discretion rather than based on established targets. These situations raise the question of whether the targets were material to the companies' policies and decisions, according to Parratt.

Parratt said the staff has heard that there is some confusion about the standard which applies when a company chooses to omit information on performance targets. In order to justify the omission of a material performance target based on the likelihood that it would cause competitive harm, Parratt said the company must engage in the same analysis that it applies to a formal confidential treatment request.

If a company discloses that is uses performance targets in its compensation programs and does not disclose those targets, Parratt said the staff is likely to ask for an explanation of the basis for the omission. She reported that in a surprising number of instances, companies have failed to develop a thorough legal analysis prior to filing.

Parratt responded to views that the staff applies a more rigorous analysis to the competitive harm standard for compensation than it does for material contracts. The staff applies the same standard to each analysis, she said. If a company believes that the staff has inappropriately concluded that its situation does not qualify for the exclusion, Parratt said it should request reconsideration.

The staff paid particular attention to competitive harm comments and responses in the 2009 disclosure. Where companies adequately explained the connection between disclosure and a performance target and the potential for competitive harm, Parratt said the staff accepted the response and agreed with the omission.

Parratt said that it is more difficult for companies to persuade the staff that the disclosure of performance targets will result in competitive harm after they have disclosed the amounts, especially where the targets are tied to company-wide financial results that are publicly reported. The staff has yet to see a persuasive analysis explaining how competitors could gather specific enough information about a company's future operations and strategy from the disclosure of these types of targets to cause the company competitive harm, she advised. Absent highly unusual circumstances, Parratt said companies should plan to disclose these kinds of performance targets if material to their compensation policies and decisions.

Parratt also pointed out that, where a company concludes that it may omit a performance target because the disclosure would cause competitive harm, it must disclose how difficult or likely it will be to achieve the target. A statement that the target is intended to be challenging is not sufficient without more detailed information, she said.

Parratt mentioned the SEC's outstanding proposal that would require disclosure about how compensation relates to risk and how a company's overall compensation policies may create incentives that affect the company's risk. This proposal may be adopted in time for the upcoming proxy season, she said, so companies should start gathering the necessary information to comply with enhanced risk disclosure. If the proposal is adopted, the staff will focus on this disclosure in its reviews.

Parratt closed by repeating her warning about waiting for staff comments to comply with the executive compensation disclosure requirements. Any company that waits should be prepared to amend its filings if the staff raises material comments, she said, so now is the time to engage in a rigorous analysis and develop comprehensive compensation disclosure.

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