By John Stuart and Kenneth Moore, Reitner, Stuart & Moore            

In January through Release Number 33-8655 (“Release”), the Securities and Exchange Commission (“SEC”) proposed significant changes to executive and director compensation and corporate governance disclosure that will refocus and change certain compensation committee practices. With a final rule expected soon, it will behoove compensation committees of ’34 Act filing companies to prepare themselves for the changed disclosure regime.  In addition, non-’34 Act filers should consider adopting certain practices within their compensation committees, as SEC disclosure requirements are increasingly viewed as “best practices” by a variety of bank regulators. 

The Release proposes both deletions and additions to executive compensation disclosure requirements. Notably, the Release proposes deletion of the requirement for an annual compensation committee report and stock performance graph. Instead, it is proposed that companies now begin their executive compensation disclosure with an introductory analysis and discussion. This analysis should summarize both the theory and practice of a company’s compensation philosophy and, according to the Release, answer the following questions:

• What are the objectives of the company’s compensation programs?

• What is the compensation program designed to reward and not reward?

• What is each element of compensation?

• Why does the company choose to pay each element?

• How does the company determine the amount (and, where applicable, the formula) for each element?

• How does each element and the company’s decisions regarding that element fit into the company’s overall compensation objectives and affect decisions regarding other elements?

The Release also proposes that the discussion be in plain English and avoid boilerplate language. In addition, and in contrast to the compensation committee report, the analysis will be “filed” material, which means there is potential liability attached to the discussion.   

Because the compensation committee sets a company’s overall compensation philosophy, determines the specific compensation for the chief executive officer and other officers, and oftentimes oversees administration of equity compensation plans, the compensation committee will need to take the lead role in crafting the new discussion. 

Although not as sweeping as the revised compensation disclosure, the Release also proposes to tinker with corporate governance disclosures. One element will be the identification of compensation committee members, the independence of such members, and inclusion of the committee charter on a company’s website or as an attachment to a proxy statement. In addition, disclosure of a company’s processes and procedures for the determination of executive and director compensation would be required including:

• the scope of authority of the compensation committee;
• the extent to which the compensation committee may delegate any authority to other persons, specifying what authority may be so delegated and to whom;
• any role of executive officers in determining or recommending the amount or form of executive and director compensation; and
• any role of compensation consultants in determining or recommending the amount or form of executive and director compensation.

The compensation committee will need to be heavily involved in writing this portion of the proposed corporate governance disclosures. 

The Release presents a significant revision to compensation disclosure, and to a lesser extent corporate governance disclosure, that will impact compensation committee practice. Compensation committees should plan ahead for an increased role in preparation of ’34 Act reports. Companies would be wise to reevaluate compensation committee charters shortly after the Release becomes final to ensure that they have the necessary authority to fulfill their changing role. Both compensation committees and the boards they serve should prepare themselves for adoption of the Release in advance to ensure a smoother transition to the new disclosure regime.

  <back to June 2006 Directors Digest>