How do you fare on these seven "red flag" disclosure issues? BY DENNIS MORRIS AND DAVID DOODY
Timing is everything. Following the splashy headlines about two high-profile CEO departures at Home Depot and Pfizer with exit packages in the $200 million range, new sec proxy rules are sure to bring even greater emphasis to the issue of CEO pay. After all, thanks to new transparency measures, CEO pay packages may appear 50 to 60 percent higher than previously disclosed.
To get a better picture of the potential impact, one need only review the charts of CEO pay packages at General Electric and Exxon. (see page 48.) Drawing on 2005 public records, it's easy to see the contrast between the pre- and post-sec ruling Summary Compensation Tables-and to identify the dilemma these new transparency rules will create.
Clearly, companies should be developing an action plan so that desired changes to compensation programs can be completed in time for the next proxy disclosure. While changes may not apply to the current group of highly compensated executives, any changes for current executives and future plans will need to be made under the new, more stringent regulations.
The new rules apply to proxy statements filed in 2007 and define the "top five executives" as the CEO, CFO and the next three most highly paid officers, which may not be the same top five highest paid for section 162 purposes. As we enter the spring proxy season and companies face the challenge of getting a handle on the Commission's massive 436-page document on this latest round of regulations, here are seven "red flag" areas on which to focus.
Red Flag #1: Detailed Disclosure of Compensation Philosophy & Governance
Replacing the Compensation Committee Report with the Compensation Discussion & Analysis (CDA) report requires a more comprehensive narrative on executive compensation philosophy. The firm's approach to marketplace benchmarking and the business rationale for each compensation element must be detailed.
Now, companies must explain what factors are considered when increasing or decreasing each compensation element and provide the reasons for differences in the programs offered to the top five executives. The report must disclose the business rationale for selecting the terms for stock options and the timing of option grants, and also its policy for recapturing compensation previously awarded when performance results are restated. Imagine if the New York Stock Exchange was required to provide a detailed explanation of former CEO Dick Grasso's compensation and retirement package; the whole Grasso compensation scandal may have been averted.
Companies with no formal compensation philosophy, or gaps in their existing compensation policies, need to address these issues. Additionally, in an accompanying Compensation Committee Report, the committee must discuss practices and procedures and other governance disclosures used in conducting its business, as well as the methodology for the review and approval of compensation programs. The report must also discuss delegation of authority, CDA review and approval of disclosures in the proxy, as well as the role executive officers and outside compensation consultants played in the compensation process.
The bottom line? Companies must review their approaches for determining compensation levels and check and reinforce committee governance practices. Developing a working draft of the CDA and governance disclosures, including identifying any gaps, can help.
Red Flag #2: Responsibilities placed on CEOs & CFOs
The SEC is placing a new level of responsibility on CEOs and CFOs for the accuracy and completeness of the CDA and accompanying tabular reports. These disclosures must be "filed," not "furnished," with the annual report and proxy statements and are subject to the full force sec regulations. Companies must substantiate the quality of …