Getting Disclosure Right Key as Executive Pay Becomes Lightning Rod

By Mary Hughes, BNA Staff Editor

Under the expanded executive compensation disclosure rules, 2009 represents the first year public companies will be presenting three full years worth of information, and it comes at a time when executive compensation is a “lightening rod” issue, speakers said during a Feb. 19 audioconference sponsored by BNA.

In drafting Compensation Discussion and Analyses (CD&As), Mark Borges, principal, with California-based Compensia, said companies must remember that the “CD&A is a reflection of what you did and not a description of what you wished you had done.” Nevertheless, he said it also is important to remember that these disclosures will be made in an environment where the economy is in a decline and public outrage over executive compensation is strong.

In addition to being a “front page” issue, the extraordinary circumstances of today's economy are leading to anomalous results, not only in the CD&A, but in presentation of tables, Borges said, suggesting that companies may have to decide whether to make additional or supplemental disclosures to “explain what the numbers mean this year.”

In this context, Borges, joined in the discussion by J. Mark Poerio, a partner at Paul, Hastings, Janofsky & Walker LLP in Washington, D.C., said it is important for a company to address how the economic crisis pertains to its compensation programs. Both speakers said an executive summary can be used for this purpose, even if the message is limited to what changes the company hopes to make. At least investors will know that “the compensation committee has a handle on the issue,” they said.

For companies that are nearly finished with their 2009 disclosures, Borges said he would not suggest that they go back and redraft, but instead they should use the executive summary as a way to address the impact of the depressed economy and market turmoil as it relates to their business and their compensation programs.

SEC's Triennial Review

In discussing the SEC staff's triennial review of executive compensation disclosures, Borges said a company should not assume its “disclosure is fine because you weren't selected in 2007,” referring to the initial SEC review of 350 public companies. Rather, Borges said, the review process has been incorporated in the Sarbanes-Oxley Act's mandated triennial review of all annual and quarterly reports, and therefore companies should expect to be reviewed approximately every three years. The staff inquiries will be more focused, their questions sharper, Borges said, and they are likely to ask about one or more of the following:

• CD&A. Borges said that now, in the third year under the revised disclosure rules, expectations are that companies will do a better job analyzing their programs. One way to ensure this is by going through the CD&A and asking questions of each major topic: mainly, how did the company arrive at the results in the tables; why did it reach those results; and, when introducing new material, asking, “Do I need to say more about how and why?”

• Incentive Compensation Arrangements. Generally, the CD&A is going to focus on the design and execution of incentive compensation programs, the speakers said. The key is to make sure the disclosures explain what the company was trying to achieve through the incentive plan, how it intended to measure performance, and how it arrived at the actual amounts paid out based on the performance as measured by the appropriate standard. The speakers emphasized that companies need to describe in some detail how and why a company selected its particular measures to drive performance and the target levels it established for each measure.

• Performance Targets. On this “hottest” issue, the speakers discussed the SEC's reaction in 2007 to companies' lack of detailed disclosure and reliance on the competitive harm argument to avoid disclosure of corporate and individual performance targets. Borges said companies selected in the triennial review should expect to provide detailed justification as to why disclosure of material information relating to corporate performance targets would result in competitive harm. He noted that competitive harm is not an easy argument to make for every performance measure. “If you are using a companywide performance measure or metric, you probably won't persuade the staff in the case of an annual incentive plan that after-the-fact disclosure will cause competitive harm,” he said.

Borges went on to discuss three items he said are critical to a more successful approach in creating a compelling argument for nondisclosure. The items are tailoring the argument to your specific company, explaining why the information you want to omit is sensitive, and demonstrating with specificity how disclosure would result in competitive harm.

Both Poerio and Borges said the SEC is not looking for specifics of individual performance objectives. Focusing their discussion mainly on disclosure issues relating to corporate objectives, including annual and multiyear plans, the speakers said in regard to multiyear incentive plans that such plans may be easier to justify than single-year plans in terms of nondisclosure of performance metrics.

• Benchmarking. Peer group selection can be an issue particularly with mid-level companies, Poerio said in reviewing the SEC staff position on this issue. The speakers said disclosing how peer groups are selected and to what use the information is put in determining compensation requires clear disclosure of whether the information was a key element in setting compensation and the selection process used. Borges also noted that companies using surveys should describe who the survey covered if it is not clear from the title of the survey.

As all parties have become more experienced with respect to disclosures over the past two years and companies' presentations have been refined, Borges said he expects, with year three, to see the SEC pay more attention to the plain English requirement. He added that “to the extent you didn't stress” putting the CD&A into plain English in 2008, “you may find you will want to review the draft . . . through the lens of plain English principles in 2009.

The audioconference was the first of two , sponsored by BNA focusing on “Executive Compensation Disclosure Update — 2009 Proxy Season.” Part 2, on Feb. 26, will focus on the CD&A, the roles of those contributing to its preparation, and a review of two very different publicly traded companies' disclosures.