Avoiding SEC Comments on Executive Compensation Disclosures

Practical Law Legal Update 8-523-0228 (Approx. 5 pages)

Avoiding SEC Comments on Executive Compensation Disclosures

by PLC Employee Benefits & Executive Compensation

Benchmarking and Peer Groups

Benchmarking is a common area of SEC comment. If a company makes any reference in its CD&A to using market data or comparative data when determining compensation, it must include a detailed description of how this data is used. In Item 402(b)(2)(xiv) of Regulation S-K, the SEC includes benchmarking of compensation as an example of material information to be disclosed in the CD&A, depending on the facts and circumstances. In Question 118.05 of the Compliance and Disclosure Interpretations (C&DIs) for Regulation S-K, the SEC defines benchmarking as using compensation data about other companies as a reference point on which, either wholly or in part, to base, justify or provide a framework for a compensation decision. The C&DI also clarifies that benchmarking does not include a situation in which a company reviews or considers a broad-based third-party survey for a more general purpose, such as to obtain a general understanding of current compensation practices. However, a company that considers third-party surveys for reasons other than benchmarking should disclose that it did so.

Some companies vaguely reference benchmarking or the use of comparative market data in their CD&As and then fail to describe how the data was used when making compensation decisions. This type of disclosure almost always results in an SEC comment requesting additional information such as:

Whether the company engages in benchmarking as defined by Question 118.05 of the C&DIs or whether the company relies on comparative data for a more general purpose.
The identity of any peer group companies whose compensation the company considered when making compensation decisions and the rationale for selecting the companies that comprise the peer group or making any changes to the peer group.
A clear explanation of how the company is using the data collected from the peer group analysis.
The targeted percentile within the peer group for each element of compensation (or total compensation if only total compensation was considered).
Based on the amount of each element of compensation or the total compensation actually paid by the company, the percentile of the peer group in which each element of the company's compensation (or total compensation) actually fell.
The reasons for any material variation between actual compensation and the targeted range.
The nature and extent of the company's ability to exercise discretion regarding benchmarking and the extent to which the company exercised discretion when using or not using comparative data.

Sample SEC Comments

"Please disclose the identity of the companies that comprised each of the surveys that you considered. Please also disclose the percentile that each component of total compensation for each of your named executive officers fell within each survey, including the focus of each survey to the extent you considered it. See Item 402(b)(2)(xiv) of Regulation S-K."

"In order for investors to better be able to understand the changes that you made to your peer group as a result of your increased size after the … acquisition, please disclose the factors that you and your consultants used in selecting and revising your peer group."

"We note your statement that when equity compensation was factored in, total compensation for your named executive officers "significantly exceeded" the 90th percentile of the market. Please disclose the actual percentile of the market attributable to your named executive officers' total compensation. See Item 402(b) of Regulation S-K."

If a company reviews broad-based surveys but does not benchmark within the SEC's meaning of the term, it should affirmatively disclose this in the CD&A. For example, a statement that the company reviews standardized surveys to check its compensation program against other companies in the same industry of a similar size and gain a general understanding of current compensation practices may satisfy SEC staff. Conversely, language in the CD&A indicating that the company considers market data when setting compensation without further explanation will almost always result in an SEC comment.

If a company benchmarks, to pass muster with the SEC, it must:

Identify the companies in its peer group.
Include detailed information about how any market data was used to determine compensation.

Factors Considered When Determining Compensation

The SEC staff frequently requests more information about how compensation was determined. This issue often arises in the context of equity award determinations, particularly if there are significant variations in the sizes or types of awards granted to executives. For example, if three out of four named executive officers received 20,000 stock options and the fourth received 30,000 stock options and a significant restricted stock unit award, the SEC staff will likely comment if the company's CD&A does not address why the fourth named executive officer was treated differently. The SEC has made this comment even when it is only the chief executive officer who is treated differently than other named executive officers.

The SEC staff has a particular interest in the effect of individual performance on compensation. Many companies reference individual performance when discussing the compensation setting process but do not provide any further detail on how performance affected each element of compensation. When this occurs, the SEC staff frequently requests additional information about the specific contributions the company took into account.

Sample SEC Comments

"We understand …. that decisions regarding compensation are derived from specific contributions of each [named executive officer] to certain objectives. Yet [you] merely provide objectives (e.g., financial performance, client service and external relations) that serve as the basis for the implementation of your compensation program, without providing corresponding discussion of how the level of performance in each of these areas impacted actual compensation awarded in [year]. Please understand that discussion of the various items of individual performance that were considered by the Compensation Committee must be accompanied by a complete qualitative and quantitative discussion of how the Compensation Committee determined to award each specific form and level of compensation in [year]. For each named executive officer, state the factors that were considered in deriving the payouts awarded for each component of compensation and provide an analytical evaluation of why the Committee determined that the specific payout was appropriate in light of the factors considered."

"We note that [Executive A] received 200,000 RSUs, comprised of 125,000 RSUs as part of the [year] equity awards and 75,000 RSUs as part of a special award, and [Executives B, C and D] received 100,000 RSUs. We also note that [Executive A] received a $5 million discretionary bonus. Finally, we note your disclosure regarding the subjective assessments made by the Compensation Committee in determining grant levels. In your response letter, please explain how each of these amounts was determined. For example, we note that with respect to [Executive A's] special award of RSUs and discretionary bonus, the Compensation Committee considered [CEO X's] recommendation, your [year] financial performance and the importance to you of [Executive A]. Please also disclose how your [year] performance together with the other listed factors led the Compensation Committee to determine to award [Executive A] 75,000 RSUs and $5 million. In future filings, please ensure that you discuss how company or individual performance relative to the parameters evaluated in making compensation awards led to the specific awards."

"Please expand your discussion to provide additional analysis of the effect of individual performance on compensation. We note that your disclosure suggests that it is considered by the Committee in determining base salary and annual incentive compensation. You should provide additional detail and analysis of how individual performance contributed to actual compensation for the named executive officers. For example, disclose the elements of individual performance, both quantitative and qualitative, and specific contributions the Committee considered in its evaluation. See Item 402(b)( 2)(vii) of Regulation S-K."

As these comments illustrate, the SEC staff is not satisfied with a CD&A that merely lists the factors that the company took into account when determining compensation. Instead, they are looking for a detailed discussion of how each factor was applied to each named executive officer to determine the officer's compensation. For example, if when setting base salaries, the company considers the individual's authority and responsibilities, market data for similarly situated executives and the executive's performance in the previous year, the company should set out in the CD&A how the company applied each of these factors to each named executive officer.

The company should highlight any special circumstances that resulted in extraordinary awards. For example, if one executive received a significant discretionary bonus because that executive covered for another executive on medical leave, this should be explained. If the chief executive officer of a struggling company agreed to forego base salary for the year in exchange for a larger than usual equity grant with challenging performance goals, the company should spell this out in the CD&A. Compensation amounts that appear out of sync with the company's regular compensation practices raise a red flag for SEC staff and should be explained to avert a comment.

For more information on preparing executive compensation disclosures, see Practice Note, Executive Compensation Disclosure: Avoiding or Responding to Common SEC Comments.

Avoiding SEC Comments on Executive Compensation Disclosures | Practical Law