SEC Wants More Concise Disclosure That is Material

The SEC has three messages for public boards and management next proxy season when it comes to disclosing policies and practices regarding executive compensation, risk and corporate governance: the Compensation Discussion and Analysis (CD&A) should be used to tell their story, all disclosures should take risks into account and should have a threshold for materiality.

In so many words, SEC Chair Mary Schapiro and a majority of commissioners want disclosures, especially the CD&A, to be less voluminous, easier to read and full of content the investors can truly use. The commission is trying to instill in public companies the idea that disclosures should be treated like a “memo” to investors and not just another compliance document.

That is what I believe directors and management should take away from the SEC’s 4-1 approval Wednesday of new rules for disclosures in proxy and information statements. The proxy disclosure enhancements, which go into effect Feb. 28, 2010, would require disclosures in the proxy and financial statements on:

•    The relationship of a company’s compensation policies and practices to risk management.
•    The background and qualifications of directors and nominees.
•    Legal actions involving a company’s executive officers, directors and nominees.
•    The consideration of diversity in the process by which candidates for director are considered for nomination.
•    Board leadership structure and the board’s role in risk oversight.
•    Stock and option awards to company executives and directors.
•    Potential conflicts of interests of compensation consultants as well as the fees paid to consultants and their affiliates.

I thought Commissioner Elisse Walter said it best when she referred to her “dear Aunt Millie.” (See video of Dec. 16 SEC meeting.)

“I can’t help but think of my dear Aunt Millie, who we try to protect each year,” Walter said. “I hope she and her Red Hat Club will open the proxy this year when she votes in a contested election.” She pointed out that individual investors should be able to get the most important information about a company from disclosures, not newspaper articles, Web sites and blogs.

Between the CD&A, Management Discussion & Analysis (MD&A) and other disclosures, the annual proxy statement should be written in a language that the “Aunt Millies” as well as institutional investors can read and understand.  At the same time, management should use such disclosures as the CD&A to make their case for their compensation policies instead of using safe boiler plate language. That is the message from the SEC, The Conference Board Task Force on Executive Compensation and at least one compensation consultant that commented on the disclosure rule amendments.

The SEC’s proxy disclosure enhancements would require a narrative disclosure about a company’s compensation policies and practices for all employees if the compensation policies and practices create risks that are reasonably likely to have a material adverse effect on the company.

The Task Force’s Principle Five – Transparent communications and increased dialogue with shareholders – among many things calls for improved disclosure. It calls for “a direct communication in ‘plain English’ from the compensation committee,” whether it is in the CD&A, compensation committee report or executive summary, is created to provide the committee’s perspective one executive compensation decisions.

The new SEC disclosure rules set a materiality threshold and use a different set of examples as to what could be disclosed if that threshold is met. Pearl Meyer & Partners, a compensation consultant, in its Sept. 15 comment letter on the proxy disclosure proposal called for both of those changes to the original proposal, as well as narrowing the scope of the compensation disclosure to executives only.

One of the SEC’s illustrative examples that should be included in the narrative for deciding whether to disclose risks related to the compensation plan include the general design philosophy of a company’s compensation policies and practices for employees whose behavior would be most affected by incentives as they relate to risk-taking.

Additionally, the SEC Wednesday approved by a 5-0 vote to amend the investment adviser custody rule, which enhances the protections provided advisory clients when they entrust their funds and securities to an investment adviser, ala Bernard L. Madoff.

Worth reading

The Conference Board Task Force on Executive Compensation report’s Principle Five details improved disclosure and communications with shareholders (page 26) and the Dissenting Opinion discusses compensation consultant fee disclosures (page 38). I would also suggest looking at the Corporate Governance Handbook: Legal Standards and Board Practices (Third Edition). On pages 80-87, there are descriptions of compensation programs, the compensation committee report, which goes into detail about the CD&A. There’s a chapter dedicated to disclosure oversight on page 111. (To read the Handbook online, members can click here. For nonmembers, click here to purchase the Handbook.)

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- Gary Larkin