What are the new SEC disclosure rules for executive compensation, especially the “risk” to the corporation of their compensation plans? How are companies dealing with these new rules — what do the early returns from this proxy season indicate? Are these new SEC requirements more of an annual risk assessment of compensation than disclosure rules — is any company really going to make a disclosure that its compensation policies create a risk to the entity? Will the RMG/ISS guidelines have as much, or more, impact than the SEC rules? How will these rules relate to pay for performance? Exactly what compensation programs are “unduly risky”? What mitigation practices will companies adopt? What are the “best practices” that should be considered?
Those were some of the issues taken up by panelists bright and early at 7:30 am at a monthly meeting of the Silicon Valley chapter of the NACD:
- Lon Allan, Chairman of the Silicon Valley chapter of the NACD.
- Katie Martin, Senior Partner at Wilson Sonsini Goodrich & Rosati’s Palo Alto office, where she practices corporate and securities law.
- Tom LaWer, Senior Partner at Compensia, a management consulting firm providing executive compensation advisory services.
- John Aguirre, Senior Partner at the law firm of Wilson Sonsini Goodrich & Rosati, specializing in executive compensation and employee benefits, including tax, ERISA and federal and state securities laws.
I’m certainly no expert in this area but I’m sure it was paradise for actual practitioners in the trenches. What follows are a few items that struck me as an interested observer. Although I know I got the order of panelists right, who said what is less certain. The links are to sites I think readers might find useful. I didn’t run them by the speakers for endorsement.
Katie Martin started with some discussion on changes to required disclosures. For example, directors must disclose seats held at any time during last five years. Legal proceedings: 10 year look back, rather than 5. Disclosure is expanded to include judicial proceedings relating to mail or wire fraud, violations of state securities, disciplinary sanctions.
Disclose experience, qualifications, attribute and skill that led to selection. Most are placing disclosures right below the biography. She discussed the new RiskMetrics Group Risk Indicators GRId (their new gov scoring system). The old CGQ scores will be frozen on March 17, 2010 and retired completely at the end of June 2010. Here’s an SEC FAQ for issuers.
My own impression, reinforced at the meeting, is that the SEC rules are largely non-prescriptive, whereas the substance of disclosures will mean more when graded by RMG. Verify the facts. Look at ways to improve. Use new D&O questionnaires, which ask directors to self-identify their particular experience, qualifications, attributes and sills.
Diversity considerations. Whether, if so, and how. The SEC rules include no mandates and the definition of diversity is being interpreted broadly.
Board leadership structure. Whether and why CEO and Chair are same or separate. If same, description of Lead Independent Director is critical. Review governance policies with respect to the role of lead independent director to consider whether further clarity is needed. Discuss and document the rationale for your current leadership structure.
Risk management oversight. Disclose the board’s responsibility for risk-management oversight. For example, is it the responsibility of entire board or is the function assigned to one or more committees for different categories of risk? This is a good opportunity to discuss these issues with the board and/or appropriate committees. Discussion will normally bring some changes and more formality. There is a trend toward having a separate risk management committee, not so much in the tech sector, but in larger firms.
With the new rules regarding 8-K requirements, we’re talking close to real-time disclosure, within 4 business days after meeting. File preliminary results, if final results not known.
Non-GAAP Financial Measures: Recent SEC Interpretations. Historically, restrictive approach by SEC to non-GAAP financial measures. Recent changes have not led to full blown non-GAAP report but anything that flushes out trends would be positive. SEC filings should be consistent with other public communications. If doing an offering, get comfort from auditors. (Revised SEC Interpretations Regarding Non-GAAP Financial Measures, Cooley Godward Kronish LLP, 2/26/10)
Focus on process aspects, risk and possible litigation. Don’t let your board get blind-sided.
John Aguirre – New Compensation Disclosure Rules: Policies and Practices Relating to Risk Management — Requires narrative disclosure regarding compensation policies and practices for all employees to the extent that risks arising from such policies and practices are “reasonably likely to have a material adverse effect on the company.” Reasonably likely is the same disclosure threshold used in the Management Discussion & Analysis. Whether disclosure is required is a facts and circumstances test for each company and its compensations programs (e.g., the program features and goals). Dodd bill may require comp committee to have their own attorney. Focus on process.
Risk disclosure, grants, and consultant fee disclosure… Forward-looking statements that don’t create risk.
SEC examples of practices that may have risk requiring disclosure included business unit that:
- carries a significant portion of company’s risk profile.
- has compensation structured significantly different from other units within the company.
- is significantly more profitable than other units.
- has compensation expenses as a significant percentage of unit’s revenues or compensation that varies significantly from the overall risk and reward structure of the company, such as when bonuses are awarded upon accomplishment of a task, while income and risk to company from task extend over a significantly longer period of time.
If disclosure is required, the SEC noted possible areas for discussion:
- General design philosophy and manner of implementation of compensation policies and practices for employees whose behavior is most affected by incentives created, as related to risk-taking on behalf of company.
- Risk assessment or incentive considerations, if any, in structuring compensation policies and practices in awarding and paying compensation.
- How compensations policies and practices relate to realization of risks resulting from employee actions in both short and long term, such as policies requiring clawbacks or imposing holding periods.
- Policies regarding adjustments to compensation policies and practices to address changes in risk profile. Material adjustments that have been made to compensation policies and practices as a result of changes in risk profile. Extent of monitoring of compensation policies and practices.
List of SEC’s examples is not exhaustive. SEC expects principles-based approach in the disclosure, similar to CD&A requirements. Avoid generic or boilerplate discussion. SEC does not require an affirmative statement that a company’s risks arising from its compensation policies and practices are not reasonably likely to have a Material Adverse Effect. If a company does not disclose any material adverse risks, the SEC likely will, in the course of its review, issue a comment asking the company to explain the nature of the internal analysis that was conducted in making its determination that no disclosure was required.
What should you do? Update board or comp committee on new rules. Consider whether compensation policies need updated. In addition to the examples John provided, which I expect may be referenced on the SVNACD site, here are some examples from Holme Roberts & Owen LLP.
Must disclose aggregate “grant date fair value” of awards computed in accordance with FASB ASC Topic 718. Whole value of the award, even if they may never get it. This effects who is covered in your table.
Tom LaWer – The SEC has set a very high bar for disclosure. If disclosures are made, expect disclosure of past issues along with disclosure of how the issue has been fixed. The rules provide a fresh opportunity to focus in on the risk assessment of compensation policies and practices. The examination will likely influence compensation plan design… Revising compensation programs to improve design based on issues uncovered in the risk review. You might indicate, for example, that policies are reviewed annually.
No generally accepted compensation principles. Best practice guidance is sometimes conflicting. Most guidance is conventional wisdom. Standards may evolve over time based on empirical research. SEC examples tend to focus on the issues for financial companies.
Again, RMG risk guidelines might be a more important driver than the SEC. He went over several practices that will get further scrutiny and possible mitigating factors. It is a good time to review and assess for correct goals, mix, use, and design flow. For example, did the person who was demoted still got their bonus because there was no discretion built into the compensation plan? Are you doubling up, because long-term and annual incentive plans are based on the same metrics? Tell shareowners how your actions ensured these problems don’t arise again.
Here are some handouts from a similar panel meeting of the Twin Cities Chapter of the National Association of Stock Plan Professionals and brief overviews from O’Melveny & Myers, Grant Thornton LLP , Seyfarth Shaw LLP., Jenner & Block, Dorsey & Whitney LLP, Ulmer & Berne LLP, Thomson Reuters, and TheCorporateCounsel.net. I hope readers find these links helpful. The panel did a great job on a rather technical topic and brought home in many examples how requirements might be addresses, especially by the predominately high tech companies of Silicon Valley. Also be sure to see SVNACD’s page with handouts and interviews, as well as a podcast from KPMG/NACD, New SEC Proxy Disclosure Rules for 2010: What Boards Are Doing to Prepare.