After three years of reviewing companies’ pay disclosures, the Securities and Exchange Commission appears to be running out of patience.
Since late 2006, when the SEC revamped its guidelines for disclosing information on the compensation of top executives, the regulator has been sending out comment letters to companies whose disclosures they consider insufficient. These companies have been asked to do a better job next time or to provide additional information in a response letter.
But now the SEC has higher expectations, warns Shelley Parratt, deputy director of the commission’s Division of Corporation Finance. “Any company that waits until it receives staff comments to comply with the disclosure requirements should be prepared to amend its filings if it does not materially comply with the rules,” she said during a two-day conference this week held by TheCorporateCounsel.net and CompensationStandards.com.
Under the sweeping changes to the Compensation Discussion and Analysis sections of proxy statements, companies are required to tabulate and describe their reasoning for bonuses, incentive awards, stock options, and severance packages for top executives. But so far, the SEC has lightly enforced the more stringent requirements, giving both itself and companies time to get used to them.
For example, in late 2007, the first year the changes were effective, the commission noted faults in the CD&As of 350 companies. In comment letters sent to those firms, the regulator niggled for minor changes — such as larger text in footnotes — and requested more discussion surrounding the rationale for executives’ pay structure.
Last year and this year, the SEC has not disclosed how many companies received comments on their CD&As. Parratt indicated, though, that by this time next year most companies will have been reviewed at least once. “If we have not reviewed your filings [yet], the chances are very good that we’re planning to do so this year,” she said.
Meanwhile, in addition to tighter reviews of CD&As, the SEC will be rethinking other kinds of disclosure requirements in the coming year. “Our goal is to determine if some information we require should be omitted, or if some information we don’t require should be added,” said SEC chairman Mary Schapiro at a securities regulation conference last week.
For example, the commission is considering whether to boost disclosure of companies’ risks tied to climate change. Environmental groups have criticized the SEC for not enforcing its rules requiring companies to report when they are involved in certain legal proceedings regarding their treatment of the environment. Studies have shown that nearly three-fourths of businesses don’t disclose their environmental liabilities in SEC filings, as required. “We are taking a very serious look at our disclosure system in this area,” SEC commissioner Elisse Walter said last month.
In addition, the SEC may revisit guidelines for the management discussion and analysis section of companies’ annual reports, which hasn’t been updated in more than five years. Walter has said management could do a better job at tipping off investors to the trends and uncertainties they are experiencing. “In my view, corporate MD&As are still not where they should be,” she said.
According to Parratt, neither are CD&As. After hundreds of comment letters on the subject and speeches from SEC staffers calling for more clarification, companies are still not offering enough analysis of certain compensation decisions, she said. At the same time, though, the SEC doesn’t want these sections stuffed with lengthy, unnecessary text. “The CD&A should not be so technical and process-oriented that it obscures the explanation of what the compensation is designed to reward,” said Parratt.
The call for more explanation is not a new one. The regulator’s staff has repeatedly emphasized that companies should provide more insight into decisions on pay packages, notes Myrna Hellerman, a senior vice president at Sibson Consulting. The SEC wants “a clearer, crisper description and defense of what has been done,” she tells CFO.com.
In particular, the SEC wants more information about incentive-pay performance targets, such as earnings per share or EBIDTA. Companies are required to discuss such metrics that are material to compensation policies and decisions — unless they can show that publicly revealing the targets could cause “competitive harm.” But Parratt suggested that with investors paying much closer attention to executive compensation, materiality thresholds could be in flux.
Parratt further noted that it’s not OK for the CD&A to omit disclosing a material target just because it is disclosed in the company’s financial statements. The goal is to make it easier for investors to decide for themselves whether an executive has been fairly — or unfairly — compensated. Observes Hellerman, “Investors are looking for reassurance that pay is aligned with performance.”
The SEC is also focused on how companies discuss the peer companies against which they benchmark their executives’ pay. While companies have come around to naming names, they have been reluctant to explain why they chose those businesses as peers. Companies have been accused of referencing much larger firms to justify what some may view as excessive pay packages.
Hellerman notes that ideally, companies should be drafting their CD&As now for the coming proxy season. However, some may be reluctant to do so, with more rule changes likely coming. The SEC is reviewing comments for proposals that would require companies to discuss any incentives for risk-taking. Also on tap is a possible mandate to make greater disclosure of conflicts of interest that can arise when both boards and company management use the same independent compensation consultant. And it appears likely that legislators will eventually pass a “say on pay” measure requiring companies to let shareholders make a nonbinding vote on executive pay.
Still, Parratt cautioned that when companies do get their 2010 proxy statements formalized, they shouldn’t shy away from the details on how they pay their executives — and shouldn’t wait for the SEC to prompt them for such specifics. “Your shareholders are reading it and are making voting and investment decisions based on it,” she said. “That should be reason enough to motivate you to make your disclosure as good as it can possibly be.”