A Few Important Proxy Compensation ... - Latham & Watkins

November 2006
The Executive Comp Insider
A Few Important Proxy Compensation Disclosure Tips
By James D.C. Barrall
Much has been written in Executive Compensation
Strategies and elsewhere about the SEC’s new executive
compensation and related-person disclosure rules,
which apply to the 2007 proxy season and require
public companies to fundamentally rethink their
approach to the disclosure of executive officer and
Director compensation. However, several noteworthy
tips and traps have emerged as companies have begun
preparing disclosure under the new rules.
The Compensation Committee should approve
(or recommend the approval of ) compensation
payable to all executive officers. In general, the new
compensation disclosure rules only require disclosure
of compensation payable by public companies to their
Directors and “named executive officers” (NEOs),
generally defined as a company’s principal executive
officer, principal financial officer and three next “most
highly compensated” executive officers. However, the
related-person transaction disclosure rules also require
disclosure of all compensation payable to any other
person who is an “executive officer” (EO), unless the
compensation has been approved (or recommended
to the Board of Directors for approval) by the Compensation
Committee or the group of independent
Directors performing a similar function if there is no
Compensation Committee. Thus, in order to avoid
unnecessary disclosure with respect to EOs who are
not NEOs in next year’s proxy, the Compensation
Committee should approve (or recommend that the
Board approve) all 2006 compensation payable to
such EOs. This approval need not be made in advance,
and the Compensation Committee or Board of
Directors may ratify the EOs’ compensation.
The CD&A is not your father’s Compensation
Committee Report. By now, compensation professionals
know that the newly-required Compensation
Discussion and Analysis (CD&A) requires much
more analysis and disclosure of a company’s philosophies
and practices on NEO compensation than
was previously required. The new rules require that
the CD&A explain every material element of NEO
compensation by answering the following questions:
1) what are the objectives of the program?; 2) what is
the program designed to reward?; 3) what is each
element of the compensation?; 4) why does the company
choose to pay each element?; 5) how does the
company determine the amount for each element?;
and 6) how do each element and the company’s
decision regarding that element fit in the company’s
overall compensation objectives and affect decisions
regarding other elements?
Our early CD&A experience has taught us the
following lessons:
• The best way to start to draft a CD&A is from
scratch, listing all of the company’s compensation
plans and arrangements and applying the SEC’s
questions to each.
• At most companies, no one person or department
will be able to draft the entire CD&A, and substantial
input is required from the Compensation
Committee and compensation consultants, who
November 2006 | Executive Compensation Strategies

historically have been most involved in designing
compensation programs at many companies.
• The drafting process at most companies will be
interactive, since questions are asked and answered,
and will require multiple drafts.
• Assembling the tabular disclosure on the various
elements of compensation will highlight issues and
plan features that probably deserve to be discussed
in the CD&A, which makes it advisable to prepare
draft tables early in the process (with estimated
2006 numbers), rather than waiting until after the
end of the year to draft the tables.
We have also found that completing a checklist
prior to drafting helps streamline the drafting process.
SOX certification requirements generally will
require CD&As to be substantially completed by
the Form 10-K filing deadline. The CD&A, unlike
the Compensation Committee Report, is part of the
proxy and is deemed to be filed with the SEC, not
merely furnished. As such, the disclosures made in the
CD&A are subject to liability under Section 10(b)
and are subject to the CEO and CFO certification
requirements of the Sarbanes Oxley Act (SOX).
CEOs and CFOs at many public companies
historically have been willing to file their SOX certifications
with the company’s Form 10-K, even though
the compensation tables were incorporated by reference
and filed in the proxy later. It is already clear that
many CEOs and CFOs will not be comfortable with
this approach, at least for the first CD&A, and will
insist that the CD&A be drafted and approved by the
Compensation Committee and by the company’s HR,
legal and accounting departments before they certify
and file the Form 10-K. For many calendar year companies,
this means that the 2006 CD&A may need to
be substantially completed by March 15, 2007, not the
end of April 2007.
that the standard for nondisclosure here is the same
standard that applies to applications for confidential
treatment with respect to registration statements and
other SEC filings. It also it appears that SEC staff
may be more rigorous in applying the standard to
CD&As than to Compensation Committee Reports
under the prior rules. Therefore, don’t assume without
analysis that you won’t be required to disclose such
things as actual performance targets, benchmarks and
peer groups, and be prepared to justify why nondisclosure
of targets would result in competitive harm to
the company. Also note that if the specific targets are
not disclosed, the company is required to discuss how
difficult it would be for the executives or the company
to achieve the undisclosed targets.
Consider including additional disclosure in the
Compensation Committee Report. While the new
rules only require that the Compensation Committee
Report state whether the Compensation Committee
has reviewed and discussed the CD&A with management
and whether it has recommended that it be
included in the company’s annual report and proxy,
Compensation Committees may wish to consider
including additional disclosure in appropriate cases.
An expression of the Compensation Committee’s
views on the company’s compensation philosophy,
plans or policies – or highlighting certain facts or issues
– could help shareholders understand and shape
any debate on large total compensation numbers, the
relationship between compensation and company
performance or unusual compensation arrangements.
James D.C. Barrall is Global Chair of the Benefits and
Compensation Group of Latham & Watkins LLP. For
more information, go to: http://www.lw.com.
Don’t assume that the specifics of performance
targets need not be disclosed in the CD&A. The
CD&A requires discussion of the performance factors
considered in setting each element of NEO compensation.
However, specific quantitative or qualitative
performance targets don’t need to be disclosed if the
disclosure of the targets would result in competitive
harm to the company. The SEC has made it clear
November 2006 | Executive Compensation Strategies