Comments Are in on SEC’s Proxy Disclosure Proposal

The Securities and Exchange Commission has received a flood of suggestions, complaints, praise, and other comments for its sweeping plans to revamp corporate proxy disclosures.

The comment period for its proposals ended last week, and the 137-page proposing release drew scores of responses to the many questions the Commission had asked. Not surprisingly, responses varied as widely as the questions themselves.

The proposing release covers a wide swath of issues, mostly dwelling on greater disclosure of risks, executive compensation, or risks stemming from executive compensation. The proposals also call for more disclosure of director nominees’ experience; disclosure of whether companies separate their chairman and CEO roles and why; and disclosure about possible compensation consultant conflicts of interests. The Commission is also proposing changes in how companies report the value of the stock and option awards granted to executives and directors, faster disclosure of shareholder voting results, and other changes to address issues related to proxy solicitations.

If the plans are enacted—and almost everyone assumes they largely will be enacted, in some form—they would most likely be effective for the 2010 proxy season.

Meanwhile, Congress is also mulling various legislative proposals that take aim at corporate compensation and governance practices, such as the Shareholder Bill of Rights introduced by Sen. Charles Schumer, further adding to the uncertainty for issuers. But as recently as last week, Sen. Christopher Dodd, chair of the Senate Banking Committee, said he didn’t expect major legislative reforms to come to a vote until next spring.

Some commenters on the SEC proposals, including Hye-Won Choi, head of corporate governance at TIAA-CREF, support them overall but cautioned that the SEC will need to take more steps to discourage companies from filing boilerplate disclosure language. To that end, Choi suggested that the SEC “reaffirm the need for disclosure to be clear, concise, customized to the company, and accessible to all shareholders.”

Schapiro

SEC Chairman Mary Schapiro herself touched on that issue in remarks she made July 1 at an SEC meeting where the commissioners voted to publish the proposals. She stressed the concept of “better or more timely disclosure, not simply additional disclosure.”

Compensation Risks

The main thrust of the proposals is to shine a spotlight on risk oversight, particularly how companies monitor the risks of excessive compensation. But Jesse Brill, chairman of the National Association of Stock Plan Professionals, said the proposals regarding risk disclosure in the Compensation Discussion & Analysis “appear to many practitioners as not providing enough specific guidance to be meaningful,” resulting in “great risk that most companies’ disclosures will fail to address specific, important action items.”

The disclosures are “much [too] complex to be casually discussed in the proxy statement in a manner understandable to the average individual investor.”

—Jack Dolmat-Connell,

CEO,

DolmatConnell & Partners

As proposed, a company would be required to discuss and analyze its “broader compensation policies and overall actual compensation practices for employees generally, including non-executive officers, if risks arising from those compensation policies or practices may have a material effect on the company.”

Farrell

Of all the measures under consideration, says John Farrell, KPMG’s lead partner for enterprise risk management, “That’s the one that’s really front and center” for issuers.

Farrell says that for companies to describe how their compensation policies affect risk taking, they will need to inventory their policies around the globe relative to their risk profiles—and that’s something most companies haven’t been doing. Particularly outside of the financial services sector, “Companies are struggling to figure out how to actualize this,” he tells Compliance Week.

Other commenters suggested that companies won’t be the only ones struggling to make sense of the proposed disclosures about the relationship between compensation policies and risk.

Dolmat-Connell

Jack Dolmat-Connell, CEO of compensation consultancy DolmatConnell & Partners, wrote that the disclosures are “much [too] complex to be casually discussed in the proxy statement in a manner understandable to the average individual investor.” He urged the SEC to delay the proposed reforms until the links between risk-taking and executive compensation “are more clearly understood and quantifiable.”

Acting too quickly, he warned, “may lead to unintended consequences when boilerplate language about risk and its relationship to compensation is included in proxy statements.”

Similarly, Chris Young, national compensation practice leader at Bucks Consulting, said that requiring disclosure concerning a company’s overall compensation program as it relates to risk-management and or risk-taking incentives “would not provide meaningful disclosures to investors.”

“This type of disclosure is likely to be exceptionally difficult for the broad spectrum of investors to interpret, thereby possibly obfuscating rather than clarifying the investment opportunities or the voting decisions required of investors,” Young wrote.

Lawyers from the firm David Polk & Wardwell said any final rule should require such discussion of compensation risks only if such risks are “reasonably likely to have a material effect on the registrant”—a subtle but important distinction from the current language, which would require discussion if the risks “may” have a material effect.

ENHANCING PROXY DISCLOSURE

The SEC believes the situations that potentially could trigger discussion and analysis include, among others, compensation policies and practices:

At a business unit of the company that carries a significant portion of the company’s risk profile;

At a business unit with compensation structured significantly differently than other units within the company;

At business units that are significantly more profitable than others within the company;

At business units where the compensation expense is a significant percentage of the unit’s revenues; or

That vary significantly from the overall risk and reward structure of the company, such as

when bonuses are awarded upon accomplishment of a task, while the income and risk to

the company from the task extend over a significantly longer period of time.

Source

Proxy Disclosure and Solicitation Enhancements (July 10, 2009).

“Basing the disclosure standard on whether the risks are “reasonably likely’ would give registrants more certainty and provide investors with a meaningful discussion and analysis, whereas the proposed “may’ standard is vague and could be interpreted to capture much more than the material information that the Commission is seeking,” the firm’s Sept. 14 letter states.

Others, including the Council of Institutional Investors support that disclosure. Justin Levis, a senior research associate at the CII, said the “may” standard should apply to all employees as currently proposed, “since opportunities and incentives for engaging in unnecessary risk-taking can extend far beyond the C-suite.”

More Questions, More Ideas

The SEC is also proposing new disclosures about a company’s leadership structure and the board’s role in the risk-management process. As it stands now, companies would be required to explain why their chosen structure is best for them, and whether and why they’ve chosen to combine or separate the principal executive officer and board chairman positions.

Governance activists have been poking Corporate America for several years to split the CEO and chairman roles. A new requirement to review their rationale for keeping the jobs unified, Farrell says, could spur some companies to changes their structure “or at least to study it … before they go ahead with that disclosure.”

The SEC also proposed changing how stock and option awards are disclosed in the Summary Compensation and Director Compensation Tables. That compensation would now need to reflect the fair value of the awards on the date they were granted, rather than on the dollar amount recognized for financial statement reporting purposes for the fiscal year.

Levis said grant-date reporting “is preferable, appropriate and consistent with pay disclosure’s overall goal of giving shareowners the tools to assess the decisions of the compensation committee.”

Others, however, said the change wouldn’t fix the confusion caused by current disclosure rules. Paul Hodgson, senior research associate at The Corporate Library, suggested the SEC have two tables: “one that indicates monies received in the year—Realized Compensation; and another that discloses the target, future level of compensation aimed at by present grants and awards—Realizable Compensation.”

Others, such as the Institute of Internal Auditors, generally support the proposals, but offered other suggestions for improving disclosure. The IIA called for compensation committees to make a formal assessment of compensation consultants’ independence, and to include that in Form 10-K; it also urged the inclusion of a formal board assessment of management’s processes to oversee risk management.

Brill also said further changes are needed to address weaknesses in the current disclosure requirements, including making the CD&A part of the Compensation Committee Report and requiring that report be “filed,” which attaches legal liability under federal securities law.