March 7, 2011

SEC Update

There have been several recent newsworthy items coming from the SEC.

  1. CD&A Clarification.  On March 4, 2011, the SEC published some brief but helpful guidance with respect to the Compensation Discussion and Analysis (CD&A) for annual proxies.  Current SEC guidance requires that companies disclose certain information between the close of the fiscal year covered by the proxy and the time the proxy is finalized.  There has always been confusion as to what is actually required.  More conservative advisers have suggested that any significant compensation action taken after the close of the year should be disclosed in detail, even if it relates to compensation payable in a year subsequent to the year covered by the proxy.  Others have taken a more literal reading of the SEC guidance and have counseled disclosure only to the extent the later compensation action was material to the understanding of compensation reported in the year covered by the proxy.  The March 4 guidance clearly supports the latter view indicating a no answer to the following question:“is a company required to discuss executive compensation, including performance target levels, to be paid in the current year or in future years?”The SEC went on to add, “the CD&A covers only compensation awarded to earned by or paid to [NEOs].’ “The SEC continues that although current guidance addresses disclosure of actions taken after the end of the year covered by the proxy, disclosure is required only to the extent necessary to provide a “fair understanding of the [NEO’s] compensation for the last fiscal year.”While there is no question this response still leaves considerable gray area, it does remove the pressure to disclose new targets and compensation for later years that may have been set after the close of the preceding year but prior to the completion of the proxy.  At least that would seem to be the case if the new targets, etc., are set in the ordinary course.  The primary benefit to this clarification is that compensation committees no longer have to be concerned that they will have to disclose, in the preceding year’s proxy, targets, compensation levels etc. that are set for the current or future years in the normal course after the end of the preceding fiscal year but before the proxy is finalized.Where the area gets a little gray is if, for example, after looking at performance, compensation, targets etc., for the preceding year, the board determines the compensation program failed to achieve the basic underlying goals and thus should be jettisoned in favor of a much different type of program.  In this case, at least general commentary might indicate the previous program needed significant alteration or replacement to achieve underlying goals and strategies for the years going forward.  Here, the subsequent decisions would seem shed light on the previous year’s compensation.
  2. Compensation Limits and Additional Disclosure of Financial Institution Disclosures.  The SEC has never really been in the business of regulating compensation pay practices other than requiring certain standards for disclosure and then penalizing companies for varying from those standards or for practices at variance with what is disclosed.  Last week the SEC released proposed rules which uniquely prohibit certain pay practices.  These rules are required under last year’s Dodd-Frank legislation to be issued by the SEC and other agencies such as the Treasury Department which regulate financial institutions.The proposed guidance requires financial institutions with assets over $1 billion to describe, in reports to their reporting agencies, components of and policies regarding incentive compensation and why the structure of such compensation arrangements will prevent the institution from material loss or does not pay excessive compensation to “covered persons”.  Covered persons are executive officers, employees, directors or principal shareholders.  The proposed rules go on to specifically prohibit incentive compensation which encourages inappropriate risks to pay excessive compensation or that could lead to material financial loss.  The proposal specifically incorporates certain standards adopted by financial regulators last year. Financial institutions with over $50 billion in assets are subject to additional restrictions including the deferral for at least three years of at least 50% of any incentive based compensation payable to executive officers (and others as determined by the institution’s board) and require reduction of the compensation for any losses suffered by the suffered by the institution after the award date.  The proposed rules are not effective until 45 days after all agencies approve them in final form.
  3. SEC Gets Personal With Inattentive Directors. A recent New York Times article  indicates the SEC has taken the unique action of filing civil charges against three outside directors.  While the case involves fraud as opposed to compensation related matters, it does suggest a willingness by the SEC to pursue especially inattentive directors—a philosophy that could easily extend to directors involved in compensation oversight.  The article raises the question of whether this signals a new SEC willingness to focus on individual board members.  The SEC indicates its assertiveness in this case is warranted by particularly egregious instances of inattention to director duties.  The belief, widely held, is that directors often escape personal responsibility even in such egregious cases because private shareholder lawsuits are settled from claims against the company’s director and liability coverage insurer.  Although some courts, such as a particular federal court in Northern California, look for personal contributions from directors in certain cases, this approach seems to be the exception rather than the rule.  Regardless, if nothing else, the recent SEC action should put directors on notice that they should be careful to establish and follow acceptable standards of diligence in any matter under their purview.