Proxy Guidance, MD&A Advice, More From SEC Brass

A top Securities and Exchange Official gave companies more advice last week on drafting considerations for their upcoming financial reports, as well as an update of the SEC staff’s recent actions and a preview of initiatives that will be keeping the SEC—and U.S. issuers—busy in coming weeks.

In remarks to the Current Financial Reporting Issues conference in New York, John White, director of the SEC’s Division of Corporation Finance, said the staff has been busy reviewing the proxy statements of companies that want to participate in the Treasury Department’s Capital Purchase Plan, but don’t have the necessary preferred stock authorized to sell to the Treasury. Companies must seek shareholder approval to get the stock authorized, and “there is a slew of companies scrambling around with proxy statements, and we’re reviewing and commenting on those so they can get to shareholders,” he said.

To accelerate that process, the Corporation Finance staff plans to issue guidance shortly, possibly in the form of a “Dear CFO” letter, to help companies anticipate the kind of questions the staff may ask, White said. He urged companies looking to raise capital or engage in strategic transactions to seek help from the staff.

White

“We don’t want the regulatory process to stand in the way of companies that need to engage in strategic transactions or companies that need to raise capital,” he said. White said the division staff has been focused in recent weeks on “making sure that any company that needs to get to market can do it efficiently … or at least without us being a roadblock.”

“If you have capital-raising transactions or strategic transactions on your plate in the coming months, you should give us a call and we’ll try to be there for you,” White told the group.

He also reminded companies what participation in the Treasury Department’s TARP program will mean for financial disclosure. According to White, there are at least seven potential 8-K items that could be triggered for companies participating in TARP, as well as “significant implications” for those companies’ quarterly and annual disclosures—particularly in the Management’s Discussion and Analysis. “You’ll need to describe your new partner, the government, and there are a number of executive comp limitations that need to be included in that discussion,” he said.

WHITE’S ANALYSIS

The following excerpt is from John White’s speech on executive compensation disclosure:

Compensation Disclosure and Analysis. To start with the positive, we have seen improvement in this area and it is clear that many companies have tried to provide meaningful disclosure explaining the rationale for their executive compensation policies and decisions. The most successful have implemented comprehensive overhauls of last year’s disclosure model that effectively refocused their disclosure—in other words, they’ve started with the clean slate, the blank sheet of paper, that I suggested last year. Yet, many others have missed the opportunity to transform their presentation into the useful analytical discussion that should be the essence of the CD&A. Rather than moving forward toward better quality disclosure, they are merely treading water. Again, as was the case last year, the “how and the why” are missing in explaining the connection between the company’s philosophies and processes and the numbers the company presents in its tabular disclosure.

The improvements we observed vary in scope depending on the size of the company and the complexity of the compensation arrangements and, while of course there is no one-size-fits-all disclosure model, it is evident that many filers of all sizes have accepted the challenge associated with improving the form and content of their executive compensation disclosure. For those that did choose to embrace the CD&A as an invitation to provide all categories of investors with the critical information necessary to understanding executive pay, we applaud your efforts. Through a more effective assessment of threshold materiality issues and a conscientious attempt to eliminate boilerplate and unnecessary narrative disclosure, these filers capitalized on the opportunity to convert their CD&As from an impenetrable disclosure document to the crisp and informative analytical discussion that is the centerpiece of this presentation.

Notwithstanding this improvement, we still commented heavily on the need for filers to concentrate their CD&A into an informative analytical discussion of:

the material elements of compensation;

how companies arrived at the varying levels of compensation; and

why they believe their compensation practices and decisions fit within their overall objectives and philosophy.

In too many cases, companies failed to provide informative analysis on one or many levels, thereby depriving investors of critical information on fundamental compensation practices and decisions. This resulted in comments from Corp Fin seeking to elicit enhanced disclosure and redirect the filer’s focus to the core analytical principles associated with faithful application of the disclosure provisions.

As we indicated in the October 2007 report, the disclosure principles require that filers provide the necessary links that allow investors to decipher the information contained in the compensation tables through a useful and readable description of the material factors underlying the compensation decisions for named executive officers. In an effort to emphasize the significance of this mandate, we continued to encourage companies to:

explain and place in context each of the specific factors considered when approving particular pieces of each named executive officers’ compensation package;

analyze the reasons why the company believes that the amounts paid are appropriate in light of the various factors it considered in making specific compensation decisions; and

describe why or how determinations with respect to one element impacted other compensation decisions.

In many instances, we observed that filers were unable to effectively apply these concepts. Such shortcomings resulted in noticeable deficiencies when it came to providing concise quantitative or qualitative disclosure that captured how companies arrived at and why they paid the compensation awarded under a specific program or plan.

For example, if company performance was considered, we commonly encouraged filers to present a complete picture of the extent to which minimum, target, or maximum levels of performance goals were achieved and how achievement of the various company performance objectives resulted in specific payouts under the applicable compensation program or plan. To the extent that a discussion of the comparison between actual results and the performance objectives used to establish compensation does not correspond with actual payouts because pay was influenced by an exercise of discretion, we commonly requested companies to provide appropriate qualitative disclosure of the reasons for the use of such discretion and how it affected actual pay. We have learned that where pay-for-performance is at issue, there is no substitute for robust disclosure of actual results, evaluation of how those results translated into specific compensation, and why the compensation awarded was consistent with the company’s overall compensation objectives...

Finally, to the extent there is a relationship between payouts from different elements of compensation, we asked companies to provide clear descriptions of the correlation between each element of compensation and how compensation decisions regarding one element impacted levels of compensation derived from other elements. Unfortunately, I must repeat a refrain from my remarks to this audience last year. We continue to detect an absence of useful disclosure addressing the extent to which compensation committees are reviewing each element of compensation individually or whether committees are engaging in a collective evaluation of all components of executive pay when establishing the various forms and levels of compensation. The absence of such a discussion impairs the ability of investors to decipher the extent to which particular components of compensation are determined in a vacuum and which elements and levels of pay are linked to assessments of total compensation or amounts that remain realizable from prior compensation.

Source

SEC’s John White (Oct. 21, 2008).

Moreover, White stressed that the recent market turmoil has spawned potential disclosure headaches for all companies’ periodic reports, not just those receiving TARP funds. “If there’s a year when you were going to go back and basically write your MD&A on a clean slate … this has really got to be that year,” he advised.

The SEC will not publish any new guidance about what companies ought to include in their MD&A now, he continued, but issuers should crack open the Commission’s 2003 interpretive release providing guidance on the MD&A to refresh their memories generally. “It’s all right there in the 2003,” he told attendees.

Comp Disclosure & More

White also referred companies to an October speech he made in New Orleans for advice on evaluating their disclosures related to executive compensation. In particular, he noted one disclosure requirement for TARP companies that could potentially apply to all companies.

Treasury regulations implementing TARP require the company’s compensation committee to meet with its senior risk officers, to police against any “incentive risks” that might nudge senior executives to take “unnecessary and excessive risks that threaten the value of the financial institution.” If the committee does find any such threats, it must take steps to limit them. And lastly the committee must certify in the Compensation Discussion & Analysis that it’s done so.

“If you look at that requirement, I think you’ll see that it has implications for everybody,” White said. Namely, if companies use some sort of incentive-based compensation (and most do), their boards should be discussing “the risks that your executives may be incentivized to take to achieve those goals.”

On other matters: White said companies should watch for more updated staff Compliance & Disclosure Interpretations in the coming weeks. The ongoing staff project to update the CDIs—which he described as “miserably out of date”—will be complete by the end of the year.

In addition, the old SEC staff accounting training manual, which includes all of the accounting advice that comes out of Corporation Finance, will be updated. Eight years in the making, the new version will be called Corporation Finance Reporting and Disclosure Interpretations. White said Wayne Carnall, chief accountant in the Division of Corporation Finance, has planned a “big, glitzy roll out” of the new document for Dec. 9.

During a wide-ranging Q&A session, White shared some of his personal views on the SEC’s proposed roadmap for U.S. adoption of International Financial Reporting Standards by U.S. issuers. He expects no substantive changes in the Corporation Finance Division’s role even in an IFRS world and said the staff would review IFRS filers the same way it reviews IFRS filers today. (Large foreign companies can now file statements in IFRS without reconciling them to U.S. Generally Accepted Accounting Principles.)

“We’d go through the same process and ask the same questions,” he said. “If we have a question about what IFRS means in some cases, which happens today, we pick up the phone and call the [International Accounting Standards Board].”

White added: “It is not our intention nor our role in Corporation Finance to be making GAAP or making IFRS. Our job is to see it’s properly applied and the appropriate disclosures accompany that.”