In my earlier post on executive compensation disclosures, I reported that the SEC may have surprised, and frustrated, many by issuing comment letters to some 300 companies on their executive compensation disclosures. Although the SEC never said they wouldn’t send out comment letters this year, that seemed to be the implied message. Now, it will be interesting to see what the SEC does with the responses to their comments–whether any companies will be forced to amend the current disclosures, or whether they will be told to take the SECs comments into account for future filings.
The first indications of the SEC’s concerns came last March, when Chair Christopher Cox (now rumored to be a strong candidate for attorney general) used his speech at a University of Southern California conference on corporate governance to provide guidance on preparing the new narrative disclosures on Compensation Discussion & Analyses (CD&A). The new executive compensation disclosure rules require narrative items to be succinct and understandable per the SEC’s ‘Plain English’ rules. But, according to Cox, far too many companies rendered over-long and difficult-to-read narratives. For example, a random sample of 40 CD&A’s averaged near 17 (the estimated number of years of schooling it would take to understand the content of the document) on the Gunning Fog index. A score of 17 is generally interpreted to be about the same level as an academic publication. Articles in the Wall Street Journal generally score between 11 and 12 on the index, and Mr. Cox stated that this would be an appropriate target for CD&A.
Many interpreted Cox’s comments to mean that the SEC would count pages, submit CD&A’s to mechanical tests, and hold companies to account for the results. Therefore, companies would have little choice but to do the same, and could expect that the SEC would require amended filings to achieve compliance with the Plain English rules. But, rumor had it that high-level SEC staff members believed that Cox had gone too far, perhaps by over-reacting to the spate of articles critical of companies’ first-time disclosures, including a featured article in the New York Times. In his own speech, John White, Director of the Division of Corporation Finance, ham-handedly downplayed Cox’s earlier pronouncements, “I also think that criticisms of the length and the language of the new disclosures can go too far.” He stated that the SEC was seeking to establish a “layered” disclosure approach with CD&A as the top layer, serving to overview the quantitative tables and narrative disclosures to come.
In addition to addressing such questions of length, language and role of CD&A, White’s speech also provided commentary on the following areas of executive compensation disclosure:
- Lack of analysis—Although many companies made a good faith effort to provide analysis, the expectations on the part of Corp. Fin. for the second year will be higher, looking to see if companies answer the “why” questions rather than the “who, what, where and when.”
- Performance targets—Less than one-half of reporting companies disclosed specific performance targets used for annual bonuses or long-term incentive pay. “The staff has heard an almost unanimous chorus from investors—confirmed privately by many in-house and law firm counsel—that companies are not providing required disclosure about performance targets.” As part of the review process, companies “…should be prepared to provide the staff with an open and full justification of their decision not to disclose the targets.”
- Alternative disclosure when performance targets are excluded—The SEC staff is considering proposing additional rulemaking to “recalibrate the rules,” in order to help investors know if the targets are “real,” and not simply guaranteed awards.
Quotations in the financial press are not kind to the SEC’s recent actions. But, it seems to me that those companies and their cheerleading executive compesation consultants "doth protest too much." I am more than suspicious that ood faith compliance with the letter and spirit of the SEC’s executive compensation disclosure requirements will expose embarrasing, if not fraudulent (remember stock option backdating?), payments to executives.