March 27, 2007

SEC Chairman Cox Expounds on CD&A and Plain English

A few weeks ago, I blogged several times about SEC Chairman’s Cox’s first comments on the incoming executive compensation disclosures. Last Friday, Chairman Cox gave another speech during which he delves deeper into why he believes that executive compensation disclosures – particularly – the CD&A is not in plain English. The part of Chairman’s speech that deals with compensation disclosures is quite long – below are just a few excerpts to give you a sense of his message:

– “I have to report that we are disappointed with the lack of clarity in much of the narrative disclosure that’s been filed with the SEC so far. Based on the early returns, the average Compensation Disclosure and Analysis section isn’t anywhere close to plain English. In fact, according to objective third-party testing, most of it’s as tough to read as a Ph.D. dissertation.”

– “For starters, the executive pay disclosures in the study were verbose. We had it in mind that they’d be just a few pages long, but the median length for the CD&As was 5,472 words, over 1,000 words more than the U.S. Constitution.”

– “Just as the Black-Scholes model is a commonplace when it comes to compliance with the stock option compensation rules, we may soon be looking to the Gunning-Fog and Flesch-Kincaid models to judge the level of compliance with the plain English rules.”

– “So where do you think our new Compensation Disclosure and Analysis sections come in, seeing as how they’re newly minted in “plain English” for the average investor? In these tests, the average Fog Index for the CD&As in the sample was 16.45. That’s about the same as an academic paper, such as a Ph.D. dissertation here at USC.”

– “But the SEC’s own qualitative review of this year’s proxy statements indicates that we have far to go before we can say that legalese and jargon have truly been replaced by plain English. It’s clear that many companies are letting lawyers have the final say on the CD&A. As the firm that undertook this study points out, many of the problems could easily have been fixed in just a few hours by a qualified copy editor. Retail investors deserve better.”

My Ten Cents: Compensation Disclosures So Far

Just like the Chairman’s last compensation disclosure speech, some lawyers are disturbed and sending me e-mails expressing their dismay (eg. they missed the point in the SEC’s adopting release that indicates that the CD&A should only be a few pages long). For those out there that have truly worked hard to meet the extensive new requirements, I can understand their frustration and expect that the SEC will be providing us with guidance to clarify their CD&A expectations for next year.

On the other hand, far too many CD&As look eerily similar to compensation committee reports from the past and don’t really provide much in the way of analysis – despite the verbosity of the CD&As! In a prior blog, I noted that some members have told me of their efforts to cut through the HR department’s attempt to put boilerplate in the proxy statement. Since then, I have heard from plenty of non-lawyers with horror stories about lawyers who don’t understand how to narrate in plain English and worse (eg. hiding things in footnotes). Clearly, the drafting process will need to be better managed next year for many companies.

I won’t even get into the horror stories I continue to hear about dysfunctional compensation committees and boards, as that is a different topic. We are re-tooling our “4th Annual Executive Compensation Conference” to ensure it’s as practical as can be – with a theme of “lessons learned.” And our companion conference – “Tackling Your 2008 Compensation Disclosures: The 2nd Annual Proxy Disclosure Conference” – will include a panel regarding the drafting process and how to manage it. So save the dates of October 9-11…

Some Compensation Disclosure Statistics

In his speech, Chairman Cox threw out a few statistics, as noted in this excerpt:

“A private sector investor relations firm, Clarity Communications, has analyzed 40 companies’ CD&As for their level of compliance with the plain English requirement. They determined that all 40 of them fall far short of accepted standards of readability. In fact, they found that most of the disclosure documents failed even to meet the readability standards that states require for insurance forms. For starters, the executive pay disclosures in the study were verbose. We had it in mind that they’d be just a few pages long, but the median length for the CD&As was 5,472 words – over 1,000 words more than the U.S. Constitution. And the longest was more than 13,500 words – a far sight longer than a full-length feature in the New Yorker.”

Here are few more statistics from a recent DolmatConnell & Partners survey:

– The median length of the CD&A was 4,726 words, nearly five times longer than many original estimates.

– Only approximately one-third (36%) of companies chose to include exact financial performance targets (for short-term incentives) in their CD&A. The remaining firms did not disclosure specific targets, presumably because these firms believe such disclosure would cause competitive harm.

[Sidenote: Broc’s favorite perk so far – Footnote 1 to the perquisites table on page 34 of Anheuser Busch’s proxy statement regarding “beer for personal use and entertaining.”]