On January 27, 2006, the Securities and Exchange Commission (SEC) released proposed rules regarding the disclosure requirements for executive and director compensation in annual proxy statements filed by public companies. The proposed rules would require public companies to revamp the way in which they report executive and director compensation each year in the proxy, and are intended to make executive and director compensation easier to understand. The proposed rules also are intended to provide stockholders information regarding executive and director compensation that is more complete, and perhaps more easily compared company to company. This is the first update to the executive and director compensation disclosure rules since 1992.
Even though the SEC’s new rules for enhanced disclosure of executive and director compensation are only proposed, it is not too early to start thinking about how your company will comply with the rules when they (or similar rules) become final. One of the SEC’s proposals is that each company must write a narrative description of its compensation policies in a report known as the Compensation Discussion and Analysis report (the “CD&A”). This report will require a comprehensive discussion of the compensation decisions made by the company and its compensation committee during the year. In order to more easily draft a complete CD&A for the 2007 proxy statement, each public company and its compensation committees should begin in 2006 to discuss and document the philosophy and intent of the compensation packages awarded to the named executive officers. (The named executive officers are the chief executive officer and the four highest paid officers.)
The SEC has set forth examples of the topics that should be included in the CD&A. Each public company must tailor the discussion to the particular facts and circumstances of its operations and executive compensation program. It is worthwhile, however, to examine the SEC’s proposed examples to determine which of the examples can be applied to your company. These examples are not intended to be comprehensive. To the extent the SEC’s examples do not fit well with your company, its operations and compensation program, management and the compensation committee should begin to identify other items that should be discussed in the CD&A.
For those who have not reviewed the SEC’s proposal, we set forth here the topics that the SEC has identified as potentially appropriate for the CD&A. As you read through the list, consider how these topics apply to your company and how they can be addressed in the materials presented to the compensation committee before each meeting and in the committee’s minutes.
- Policies for allocating between long-term and currently paid out compensation;
- Policies for allocating between cash and non-cash compensation, and among different forms of noncash compensation;
- For long-term compensation, the basis for allocating compensation to each different form of award;
- For equity-based compensation, how the determination is made as to when the award is granted;
- What specific items of corporate performance are taken into account in setting compensation policies and making compensation decisions;
- How specific elements of compensation are structured to reflect these items of the company’s performance and the executive’s individual performance;
- The factors considered in decisions to materially increase or decrease compensation;
- How compensation or amounts realizable from prior compensation (e.g., gains from prior option or stock awards) are considered in setting other elements of compensation (e.g., how gains from prior option or stock awards are considered in setting retirement benefits);
- The impact of accounting and tax treatments of a particular form of compensation;
- The company’s equity or other security ownership requirements or guidelines (specifying applicable amounts and forms of ownership), and any company policies regarding hedging the economic risk of such ownership;
- Whether the company engaged in any benchmarking of total compensation or any material element of compensation, identifying the benchmark and, if applicable, its components (including component companies); and
- The role of the executive officers in the compensation process.
If you are responsible for preparing the materials presented to the compensation committee before each meeting, consider how those materials address the topics identified by the SEC as relevant to the executive compensation program. By addressing these topics on an on-going basis throughout the year, and recording them in the committee’s meeting materials and minutes, you will have a road map to preparing the CD&A. This roadmap will prevent companies from having to create after-the-fact an explanation of the reasons for certain compensation decisions made possibly a year or more prior to the time the CD&A is actually drafted.
The SEC’s rules are proposed; however, representatives of the SEC have said that they intend the rules to be effective for the 2007 proxy season. Even if the final rules are delayed, addressing these issues in 2006 will be a useful start to ultimately complying with the new rules when they do become final.
Please contact us if we can be of assistance in assisting with the development of compensation committee materials, providing additional background with respect to the SEC’s proposed proxy rules, or helping to identify topics specific to your company’s executive compensation policies that were not addressed directly by the SEC.
