Release No. 33-8655
Release No. 34-53185

Release No. IC-27218

Securities and Exchange Commission

Executive Compensation and Related Party Disclosure
Section II - II.A.4

    Release Table of Contents

II. Executive and Director Compensation Disclosure

As discussed above, executive and director compensation disclosure has been required since 1933, and the Commission has had disclosure rules in this area since 1938.In 1992, the Commission proposed and adopted substantially revised rules that embody our current requirements.⁴⁹ In doing so, the Commission moved away from narrative disclosure and back to using tables that permit comparability from year to year and from company to company. We believe that while the reasoning behind this approach remains fundamentally sound, significant changes are appropriate. Much of the concern with the current tables is also their strength: they are highly formatted and rigid.⁵⁰ Thus, information not specifically called for in the tables is sometimes not provided. For example, the highly formatted and specific approach has led some to suggest that items that do not fit squarely within a "box" specified by the rules need not be disclosed.⁵¹ As another example, because the tables do not call for a single figure for total compensation, that information is generally not provided, although there is considerable commentary indicating that a single total figure is high on the list of information that some investors wish to have. To preserve the strengths of the current approach and build on them, we propose several steps:

first, retaining the tabular approach to provide clarity and comparability while improving the tabular disclosure requirements;

second, confirming that all elements of compensation must be included in the tables;

third, providing a format for the Summary Compensation Table that requires disclosure of a single figure for total compensation; and

finally, requiring narrative disclosure comprising both a general discussion and analysis of compensation and specific material information regarding tabular items where necessary to an understanding of the tabular disclosure.⁵²

A. Compensation Discussion and Analysis

We propose requiring a new Compensation Discussion and Analysis section.⁵³This section would be an overview that would provide narrative disclosure that puts into context the compensation disclosure provided elsewhere.⁵⁴ This overview would explain material elements of the particular companys compensation for named executive officers by answering the following questions:

what are the objectives of the companys compensation programs?

what is the compensation program designed to reward and not reward?

what is each element of compensation?

why does the company choose to pay each element?

how does the company determine the amount (and, where applicable, the formula) for each element?

how does each element and the companys decisions regarding that element fit into the companys overall compensation objectives and affect decisions regarding other elements?

1. Intent and Operation of the Proposed Compensation Discussion and Analysis

The purpose of the Compensation Discussion and Analysis disclosure would be to provide material information about the compensation objectives and policies for named executive officers without resorting to boilerplate disclosure. The Compensation Discussion and Analysis is intended to put into perspective for investors the numbers and narrative that follow it.

The proposed Compensation Discussion and Analysis requirement would be principles-based, in that it identifies the disclosure concept and provides several illustrative examples. The application of a particular example must be tailored to the company. However, the scope of the Compensation Discussion and Analysis is intended to be comprehensive, so that it would call for discussion of post-termination as well as in-service compensation arrangements.⁵⁵ Boilerplate disclosure would not comply with the proposed item. Examples of the issues that would potentially be appropriate for the company to address in given cases in the Compensation Discussion and Analysis include the following:

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 award;

for equity-based compensation, how the determination is made as to when the award is granted;

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 to reflect these items of the company's performance and the executives individual performance;

the factors considered in decisions to increase or decrease compensation materially;

how compensation or amounts realizable from prior compensation (e.g., gains from prior option or stock awards) are considered in setting other elements of compensation (e.g., how gains from prior option or stock awards are considered insetting retirement benefits);

the impact of accounting and tax treatments of a particular form of compensation;

the companys equity or other security ownership requirements or guidelines specifying applicable amounts and forms of ownership), and any company policies regarding hedging the economic risk of such ownership;

whether the company 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 Compensation Discussion and Analysis should be sufficiently precise to identify material differences in compensation policies and decisions for individual named executive officers where appropriate. Where policies or decisions are materially similar, officers could be grouped together. Where, however, the policy for an executive officer is materially different, for example in the case of a principal executive officer, his or her compensation would be discussed separately.

2. Proposed Instructions to Compensation Discussion and Analysis

We are proposing instructions to make clear that the Compensation Discussion and Analysis should focus on the material principles underlying the companys executive compensation policies and decisions, and the most important factors relevant to analysis of those policies and decisions, without using boilerplate language or repeating the more detailed information set forth in the tables and related narrative disclosures that follow. We also propose to include an instruction to make clear, as is currently the case, that companies are not required to disclose target levels with respect to specific quantitative or qualitative performance-related factors considered by the compensation committee or the board of directors, or any factors or criteria involving confidential commercial or business information, the disclosure of which would have an adverse effect on the company, similar to the instruction with respect to the Compensation Committee Report today. In applying this instruction, we intend the standard for companies to use when determining whether disclosure would have an adverse effect on the company to be the same one that would apply when companies request confidential treatment of confidential trade secrets and commercial or financial information that otherwise is required to be disclosed in registration statements, periodic reports and other documents filed with us.⁵⁶Similarly, to the extent a performance target has otherwise been disclosed publicly, disclosure under Item 402 would be required.

3. "Filed" Status of Compensation Discussion and Analysis

The Compensation Discussion and Analysis will be considered a part of the proxy statement and any other filing in which it is included. Unlike the current Compensation Committee Report and Performance Graph, which would be eliminated under our proposals, as discussed below, the proposed Compensation Discussion and Analysis would be soliciting material and would be filed with the Commission. Therefore, it would be subject to Regulations 14A or 14C and to the liabilities of Section 18 of the Exchange Act.⁵⁷ In addition, to the extent that the Compensation Discussion and Analysis and any of the other disclosure regarding executive officer and director compensation or other matters is included or incorporated by reference into a periodic report, the disclosure would be covered by the certifications that principal executives officers and principal financial officers are required to make under the Sarbanes-Oxley Act of 2002.⁵⁸

In adopting the current rules in 1992, the Commission took into account comments that the Compensation Committee Report should be furnished rather than filed to allow for a more open and robust discussion in the reports.⁵⁹ Little that we see incurrent Compensation Committee Reports suggests that this treatment has resulted in such discussions, or at least the more transparent disclosure that the comments suggested would result. Further, we believe that it is appropriate for companies to take responsibility for disclosure involving board matters as with other disclosure.

4. Proposed Elimination of the Performance Graph and the Compensation Committee Report

In light of the Compensation Discussion and Analysis proposal, we propose to eliminate the Performance Graph and the Compensation Committee Report that currently are required by our rules.⁶⁰ The graph and the report were intended to be intertwined and their purpose was to show the relationship, if any, between compensation and corporate performance, as reflected by stock price. Unfortunately, the Compensation Committee Report today often results in boilerplate disclosure that is of little benefit to investors.⁶¹Further, given the widespread availability of stock performance information about companies, industries and indexes through business-related Web sites or similar sources, we believe that the requirement for the Performance Graph is outdated, particularly since the disclosure in the Compensation Discussion and Analysis regarding the elements of corporate performance that a given companys policies might reach is intended to allow broader discussion than just that of the relationship of compensation to the performance of the company as reflected by stock price.

Request for Comment

Does the proposed Compensation Discussion and Analysis provide companies with the same flexibility as MD&A to provide a clear picture to investors?

Are there any further changes that we can make to avoid boilerplate disclosure about executive compensation?

Is there any significant impact by not having the report over the names of the compensation committee of the board of directors? If so, please explain in detail.

Would any significant impact result from treating the Compensation Discussion and Analysis as filed and not furnished? A commenter that prefers furnishing over filing should describe any benefits that would be obtained by treating the material as furnished. In particular, such a commenter should describe those benefits in the context of the expected benefits of the Commissions decision in1992 to treat the report of the Compensation Committee as furnished and should address whether and why those benefits were achieved or not achieved.

Are there any other specific items we should list in the rule as possibly material information? Are there any items that are listed that should not be?

Are there any items that we should explicitly mandate be disclosed by every issuer?

Should performance targets continue to be excludable based on the potential adverse competitive effect on the company of their disclosure? Why or why not? If so, what should be the standard for exclusion? Are there any other items that should be excludable based on potential adverse competitive effect on the company of their disclosure?

Should we retain the Performance Graph?

⁴⁹ 1992 Release.

⁵⁰ See, e.g., Council of Institutional Investors Discussion Paper on Executive Pay Disclosure, Executive Compensation Disclosure: How it Works Now, How It Can Be Improved, at 11(available at www.cii.org/site files/pdfs/CII_pay_primer_edited.pdf).

⁵¹ For examples, see, e.g., The Corporate Counsel (Sept.Oct. 2005) at 6-7; The Corporate Counsel (Sept. Oct. 2004) at 7; but see Alan L. Beller, Director, Division of Corporation Finance, U.S. Securities and Exchange Commission, Remarks Before Conference of the NASPP, The Corporate Counsel and the Corporate Executive (October 20, 2004) (indicating that the explicit language of the current rules requires disclosure of such items), available at www.sec.gov/news/speech/spch102004alb.htm.

⁵² The discussion that follows focuses on changes to Item 402 of Regulation S-K, with Section II.C.1 explaining the different modifications proposed for Item 402 of Regulation S-B. References throughout the following discussion are to current or proposed Items of Regulation S-K, unless otherwise indicated.

⁵³ Proposed Item 402(b). In addition to the narrative Compensation Discussion and Analysis, we are proposing revisions to the rules so that, to the extent material, additional narrative disclosure would be provided following certain tables to supplement the disclosure in the table. See, e.g., Section II.B.3., discussing the narrative disclosure to the Summary Compensation Table and supplemental tables. We are also proposing disclosure of compensation committee procedures and processes as well as information regarding compensation committee interlocks and insider participation in compensation decisions as part of proposed Item 407 of Regulation S-K. See Section V.D., below.

⁵⁴ See Jeffrey N. Gordon, Executive Compensation: Whats the Problem, Whats the Remedy? The Case for Compensation Discussion and Analysis, 30 J. Corp. L. (forthcoming Spring 2006)(arguing that the SEC should require proxy disclosure that includes a "Compensation Discussion and Analysis" section that collects and summarizes all the compensation elements for senior executives, providing a "bottom line assessment" of the different compensation elements and an explanation as to why the board thinks such compensation is warranted). Also available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=686464.

⁵⁵ Forward looking information in the Compensation Discussion and Analysis would fall with the safe harbor for disclosure of such information. See Securities Act Section 27A [15 U.S.C. 77z-2]and Exchange Act Section 21E [15 U.S.C. 78u-5]).

⁵⁶ See Securities Act Rule 406 [17 CFR 230.406] and Exchange Act Rule 24b-2 [17 CFR 240.24b-2](incorporating the criteria for non-disclosure set forth in Exemption 4 of the Freedom of Information Act [5 U.S.C. 552(b)(4)] and Exchange Act Rule 80(b)(4) [17 CFR 200.80(b)(4)]).Todays proposed rules, like the current rules, would not require a company to seek confidential treatment under the procedures in Securities Act Rule 406 and Exchange Act Rule 24b-2.

⁵⁷ 15 U.S.C. 78r.

⁵⁸ Exchange Act Rules 13a-14 [17 CFR 240.13a-14] and 15d-14 [17 CFR 240.15d-14]. See also Certification of Disclosure in Companies Quarterly and Annual Reports, Release No. 34-46427 (Aug. 29, 2002) [67 FR 57275], at note 35 (the "Certification Release") (stating that "the certification in the annual report on Form 10-K or 10-KSB would be considered to cover the Part III information in a registrants proxy or information statement as and when filed").

⁵⁹ 1992 Release, at Section II.H.

⁶⁰ The Compensation Committee Report is currently required by Item 402(k) and the Performance Graph is currently required by Item 402(l).

⁶¹ See Martin D. Mobley, Compensation Committee Reports Post-Sarbanes-Oxley: Unimproved Disclosure for Executive Compensation Policies and Practices, 2005 Column. Bus. L. Rev. 111(2005).