On October 9, 2007, the Division of Corporation Finance (the "Division") of the Securities and Exchange Commission (the "SEC") released its review of the principal comments that it has provided to 350 companies regarding executive compensation disclosure in their respective 2007 proxy statements.¹ The guidance was intended to assist companies in the preparation of their disclosure for their 2008 annual meetings.

The Division focused on two principal themes:

• Companies need to use plain English and organize tabular and graphical information in a way that aids a reader's understanding of a company's disclosure.
• The Compensation Disclosure and Analysis Section required by the Revised Rules ("CD&A") needs to focus on how and why a company arrives at specific executive compensation decisions and policies to help readers understand the basis and context for granting the various types and amounts of executive compensation. In a word, the SEC is demanding meaningful and comprehensive analysis of a company's executive compensation decisions.

I. Manner of Presentation

The Division suggested various ways companies could improve their executive compensation disclosure. In particular, the Division stated that "we have often found that where a company emphasizes material information and de-emphasizes less important information, investor understanding of the company's disclosure is improved."

II. Format

A. Location of Required Compensation Tables

The Division noted that CD&A is "meant to be a narrative overview at the beginning of the compensation disclosure, putting into perspective the numbers in the tables that follow it."

B. Voluntary Disclosure

The Division also noted that approximately two-thirds of the companies included charts, tables and graphs not specifically required by the Revised Rules, but emphasized generally that this additional presentation could enhance investor understanding.

• Termination or Change-In-Control Payment - If a company included termination and change-in-control payment tables, the Division suggested that it disclose the total payments its named executive officers would receive upon termination or a change-in-control.
• De-emphasis of Alternative Compensation Tables - If a company disclosed alternative compensation tables that were confusing or calculated in a manner inconsistent with the Revised Rules, it was asked to de-emphasize the alternative summary compensation table to ensure that it was not presented more prominently than a required table. Additionally, companies were asked to use a title that would not imply that the table is required, and where necessary to explain that an alternative summary compensation table is not a substitute for the information required under the Revised Rules. Companies were also asked to explain the differences between the compensation amounts set forth in the alternative presentations and the compensation amounts under the required tables.

III. Clarity

A. Principles of Plain English

An underlying notion behind the Revised Rules is the use of plain English principles.

B. Avoidance of Boilerplate Disclosure

Companies must provide material information about the compensation objectives and policies for named executive officers without resorting to boilerplate disclosure.

• Tailoring Disclosure to Specific Facts and Circumstances - Companies must provide a clear and concise discussion of their own facts and circumstances. Specifically, companies must replace boilerplate discussions of individual performance in the CD&A with specific analysis of how the compensation committee evaluated and used individual performance to determine levels of executive compensation.
• Repetition of Disclosure - If a company repeated in the CD&A information from the required compensation tables, the Division asked it to replace its disclosure with a "clear and concise analysis of the information in the required compensation tables, or to relocate the discussion to the narrative following the appropriate tables or footnotes to those tables."
• Using Compensation Plan or Employment Agreement Language - Rather than quoting the language in a compensation plan or an employment agreement, companies must present the information in an understandable manner in plain English.

IV. CD&A

The Revised Rules require principles-based disclosure, which requires each company to assess its own facts and circumstances, and to provide analysis accordingly.

A. Compensation Philosophies and Decision Mechanics

For the companies that discussed their compensation philosophies and decision mechanics, the Division requested that they focus their CD&A on the substance of their compensation decisions. Specifically, companies should analyze information and explain why the compensation was paid. The Division suggested that companies explain how and why their philosophies resulted in the specific numbers set forth in the required compensation tables.

The Division requested companies to discuss how the amounts paid or awarded under each compensation element affected their decisions pertaining to amounts paid or awarded under other compensation elements. Specifically, the Division was interested in how and why the disclosures pertaining to one compensation element may or may not have influenced decisions with respect to other compensation elements that a company contemplated or ultimately awarded.

B. Performance Targets

1. General

The Division noted that it found it difficult to understand how companies used performance targets or how they considered qualitative individual performance to set compensation policies and make compensation-related decisions.

2. Principles-Based Disclosure

The Division noted that a substantial percentage of the companies hinted at using, or disclosed that they used, corporate and individual performance targets to set compensation policies and make compensation decisions. Such targets "ranged from financial targets, including earnings per share, EBITDA, and growth in net sales, to operational or strategic goals such as increases in market share or targets specific to a particular division or business unit." The Division noted that most of the companies did disclose that their respective compensation committees considered individual performance in making executive compensation decisions, but that very few of the companies disclosed the analyses behind such decisions. The companies also did not discuss whether they focused on individual performance goals as part of their executive compensation decisions.

3. Omitted Disclosures

Companies must disclose a performance target that is material to a company's policy and decision-making processes or demonstrate that the disclosure of such policy or decision-making processes could cause it competitive harm.²

• Disclosure Regarding Likelihood of Achieving Target - Companies must discuss how difficult it will be for the executive or how likely it will be for the company to achieve undisclosed target levels or other factors, with detail sufficient to provide an investor with an understanding of the likelihood.
• Presentation of Non-GAAP Financial Figures - If a company presented a non-GAAP financial figure as a performance target and the company did not disclose how such figure would be calculated, the Division asked it to disclose how it would do so.

4. Time Frame for CD&A Disclosures

The Division noted that, given a company's facts and circumstances, it may be necessary for a company to discuss prior and current year performance targets to provide investors with a context and full understanding of a named executive officer's compensation and also, if material, to disclose whether the company or a named executive officer achieved or failed to achieve targets in prior years. If a company's disclosure implied that its current or prior year targets were material to a full understanding of an executive officer's compensation for the last year, the Division asked the company to disclose prior year and current year performance targets.

C. Benchmarks

If benchmarking is material to its compensation policies and decisions, the company must identify the benchmark, its components and component companies. For example, it should provide (i) a detailed description of comparative compensation information and (ii) details pertaining to the peer group.

D. Change-in-Control and Termination Arrangements

Companies must analyze change-in-control and termination arrangements with named executive officers, including why they structured the material terms and payment provisions in these arrangements, and how the payments under the arrangements may influence decisions pertaining to other compensation elements. These arrangements were a particular focus of the Division.

E. Related Person Transaction Disclosure

The Division noted that companies were asked to provide a statement that their policies and procedures for review, approval, or ratification of related person transactions are in writing and, if not, to explain how they evidence their policies and procedures.

F. Corporate Governance

The Division focused its corporate governance comments on the persons involved in making compensation decisions. The Division asked the company to describe the role of executives in the compensation decision-making process. Additionally, a company was asked to disclose the nature and scope of a consultant's assignment and any material instructions provided to the consultant by the company.

For Further Information

We are prepared to assist you in revising your CD&A and your other compensation disclosures. If you have any questions regarding the Division's comments, including how they may affect your company, please contact one of the members of our Securities Law Practice Group or the lawyer in the firm with whom you are regularly in contact.

Footnotes

1. On November 7, 2006, the SEC's revised rules regarding executive compensation disclosure became effective (the "Revised Rules"). In 2007, the Division reviewed executive compensation and other related disclosure of 350 public companies to evaluate compliance with the Revised Rules and provide guidance on how those companies could enhance their executive compensation disclosure. As set forth in the SEC's October 9, 2007 review entitled "Staff Observations in the Review of Executive Compensation Disclosure," the review reflected only the SEC's initial comments and does not indicate how companies may have proposed to revise their disclosure in response to the SEC's comments.
2. The Division noted that if a company believes its explanation should receive confidential treatment, it should determine whether requesting confidential treatment of that explanation is appropriate under Rule 83. Rule 83 requires that a company submit a written request for confidential treatment at the time it provides the information to the Division.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.