SEC Executive Compensation Disclosure Guidelines – Best Practices to Follow

• By: Staff Editor
• Date: October 07, 2011

The Compensation Committee Revised Rules of 2006 require that all compensation earned by a company’s senior executives (chief executive officer, chief financial officer, and three most-highly-compensated officers, earning above USD 100,000) in the last fiscal year be disclosed.

The disclosure should contain the following three main elements:

1. Details of the compensation in a tabular form, in simple English.
2. A narrative of the above (1) and any other additional compensation.
3. A Compensation Discussion and Analysis (CD&A) statement.

Importance of CD & A: Potential Liability

While the current and the new form of the Compensation Committee report is a document that is “furnished” to the SEC, the CD&A is a “filed” document. This technical distinction means the:

• CD&A will be regarded as part of the proxy statement, and
• disclosures will be covered by the Sarbanes-Oxley certifications required of principal executive officers and principal financial officers.

Increased attention is being given to the statement owing to the potential liability.

Objectives of the CD&A
 

The SEC, in the relevant section, looks upon the CD&A as an “overview providing a narrative disclosure that puts into context the compensation disclosure provided elsewhere” for a company’s named executive officers. The objective is to “explain material elements” of these executives’ compensation through six questions that must be addressed:

1. What are the objectives of the company’s compensation programs?
2. What is the compensation program designed to reward?
3. What is each component of compensation?
4.  Why does the company choose to pay each component?
5. How does the company determine the amount (and, where applicable, the formula) for each component?
6. How does each component and the company’s decisions regarding that component fit into the company’s overall compensation objectives and affect decisions regarding other components?

The following is the format of the Summary Compensation Table:
 

Description of compensation and narrative
 

The following should be borne in mind while describing the compensation and narrative:

1. The named executive officers whose compensation should be disclosed are: the CEO, the CFO, and the three highest compensated officers, earning above USD 100,000.
2. Salary and Bonus: Companies must disclose in the salary and bonus column the dollar value of salary and bonus (cash and non-cash) earned by the executive officers during the last fiscal year. Companies should report in the bonus column, the non-equity guaranteed or discretionary bonuses, hiring bonuses, and/or relocation bonuses.
3. Stock Awards and Option Awards: “Stock awards” are equity awards whose value are derived from the company’s equity or may be settled by issuance of the company’s equity securities. Option awards include stock options, stock appreciation rights, and other similar instruments with option-like features. The value of earnings on equity awards (e.g., dividends or dividend equivalents) is generally not required to be reported, because the value of the earnings is already reflected in the calculation of the grant-date fair value of the award.
4. Non-Equity Incentive Plan Compensation Column: Non-equity incentive plans are incentive plans that are not covered by FAS (Financial Accounting Standards) 123R for financial reporting.
5. Change in Pension Value and Non-Qualified Deferred Compensation earnings: This should include any change in the company’s pension plan and the value of any preferential earnings under the company’s non-qualified deferred compensation plans.
6. All other compensation: Any compensation that cannot be reported in the other relevant columns should be reported here. Companies must identify and quantify each component that ex-ceeds USD 10,000. It includes:

• Value of securities purchased at a discount.
• Post-termination payments.
• Company contributions to defined contribution plans {e.g. 401(K) plans)}.
• Value of life insurance premiums paid by the company.
• Certain dividends.
• Value of all tax reimbursements.
• Value of perquisites with an aggregate value of at least USD 10,000. Any benefit that is not directly related to the performance of the executive's duty and confers a personal benefit is a perquisite, according to SEC.

The following are SEC examples of items that are perquisites or personal benefits:

• Personal use of a company plane
• Security provided at a personal residence or during personal travel
• Commuting expenses (whether or not provided for the company’s convenience or benefit)
• Personal travel using vehicles owned or leased by the company
• Housing and other living expenses (including relocation assistance)
• Clerical or secretarial services for personal matters
• Club memberships not exclusively used for business entertainment
• Personal financial or tax advice or investment management services
• Discounts on company products or services not generally available to all employees

SEC examples of items that are not perquisites or personal benefits are as follows:

• BlackBerry or laptop computer
• Business travel
• Business entertainment
• Security during business travel
• Itemized expense accounts used solely for business

7. The “Grants of Plan-Based Awards Table” follows and supplements the Summary Compensation Table. It provides additional information about the plan-based compensation disclosed.
8. “Outstanding Equity Awards at the Fiscal Year-End Table”: Outstanding option awards and unvested stock held by the executive in the last fiscal are detailed here.
9. “Option Exercises and Stock Vested Table”: The number and total value of stocks and options of the executive in the last fiscal year.
10. Pension Benefits Table: The company must disclose the present value of total benefits under the pension plan of the executive for the last fiscal year.
11. In the Non-Qualified Deferred Compensation Table, companies have to disclose the following details:
    1. I. Contributions of the executive in the last fiscal year.
    2. II. Company contributions in the last fiscal year.
    3. III. Aggregate earnings in the last fiscal year.
    4. IV. Aggregate withdrawals in the last fiscal year.
    5. V. Aggregate balance in the last fiscal year.
12. 12. Under the new rules, companies must use simple, short sentences, with everyday words, that is, “plain English”, in the periodic reports or proxy statements.

Compensation Discussion and Analysis (CD & A): Examples provided by the SEC of issues to be addressed in the CD&A section:

• What specific items of corporate performance are taken into account in setting compensation policies and making compensation decisions;
• How specific elements of compensation are structured and implemented to reflect these items of the company’s performance and the executive’s individual performance;
• Factors considered in decisions to increase or decrease compensation materially;
• Policies for allocating between long-term and currently paid out compensation;
• Policies for allocating between cash and non-cash compensation, and among different forms of non-cash compensation;
• For long-term compensation, the basis for allocating compensation to each different form of the award;
• How the determination is made as to when awards are granted, including awards of equity-based compensation such as options;
• Company policies and decisions regarding the adjustment or recovery of awards or payments if the relevant company performance measures upon which they are based are restated or otherwise adjusted in a manner that would reduce the size or an award or payment;
• How compensation or amounts realizable from prior compensation are considered in setting other elements of compensation (e.g., how gains from prior option or stock awards are considered in setting retirement benefits);
• The basis for selecting particular events as triggering payment with respect to post-termination agreements (e.g., the rationale for providing a single trigger for payment in the event of a change-in-control);
• The impact of accounting and tax treatments of a particular form of compensation;
• The company’s equity or other security ownership requirements or guidelines and any company policies regarding hedging the economic risk of such ownership;
• Whether the company is engaged in any benchmarking of total compensation or any material element of compensation, identifying the benchmark and, if applicable, its components (including component companies); and
• The role of executive officers in the compensation process.

The following are the significant effects of CD&A disclosure on the executive compensation strategy after the 2006 report:

1. Less emphasis on salary: Since salary increases have to be explained to the public, companies are going in for more performance-linked incentives. Sometimes even the base salary level is being determined by the stock price.
2. Formula-based incentives: The present trend is towards objectively quantifiable formula-based plans.
3. Use of performance-based restricted stock incentives is on the rise. There is an increase in stock ownership and retention guidelines.
4. Compliance with IRC section 162 (m): According to the SEC, the Board Compensation Committee Report must disclose a company’s policy with regard to section IRC 162 (m). This section of IRC limits deductibility of top executive pay packages to USD 1 million per year.

Best Practices for Executive Compensation Disclosure
 

Some of the recommended actions for compliance with SEC on this issue are:

1. To satisfy the enhanced disclosure standards and give a lengthy narrative of issues, each com-pany with its advisors (attorneys, accountants, and/or compensation consultants) should start early in their work on the CD&A.
2. Companies should develop an overall understanding of the objectives and requirements, for the CD&A.
3. The Compensation Committee should be involved. The SEC clearly expects that decisions of Compensation Committees be impacted by the knowledge that it will be subject to full disclosure.
4. The company should identify issues that will need to be addressed in the information to be included in the CD&A. Minutes of Compensation Committee meetings, reports of internal staff and consultants, and various plan documents can be used for this process.
5. A draft CD&A should be circulated in the working group for comments. All parties should keep in mind the ultimate goal of a clear, yet comprehensive overview of the company’s executive pay.

Sources:
1. http://www.sec.gov/rules/final/2006/33-8732afr.pdf
2. http://www.haygroup.com/downloads/us/Hay_Group_New_Executive_Pay_Disclosure_Rules.pdf
3. http://www.rrdonnelley.com/financial/Downloads/PDF/RR%20Donnelley%20Revised%20Executive%20Comp%20Guide.pdf