Friday, June 30, 2006

Executive Compensation Disclosure — Certification an Unintended Consequence?

A major change to executive compensation reporting proposed by the SEC is the introduction of a Compensation Discussion & Analysis piece, which is modeled on the currently required MD&A. The CD&A will give management a chance to explain its compensation policies in a narrative format. But, since the SEC proposes to require that the CD&A be filed, it could become subject to certification by the principal executive and financial officers as required by Sarbanes-Oxley. Commenters on the proposal have generally asked the SEC not to require that the CD&A be filed.

One of the more compelling comment letters in this vein is from the American Bar Association, Committee on Federal Securities Regulation. The committee’s argument is that requiring the filing of the new proposed Compensation Discussion & Analysis could lead to executive officer involvement in the compensation process and run counter to sound corporate governance.

According to the committee, the proposed change runs counter to the recent corporate governance trend of disengaging executive officers from the decision-making role in determining executive pay. If the discussion of executive compensation becomes a report of the company and therefore is required to be certified by the chief executive and financial officers, reasoned the committee, those individuals will need greater access to the compensation committee’s considerations in order to provide a basis for certifying to the best of their knowledge that the CD&A does not omit to state a material fact.

The bar committee believes that this is an unintentional but inappropriate consequence of the SEC’s proposal that runs counter to the corporate governance goal of making directors more directly accountable for executive compensation decisions. This is quite ironic since, if the committee is right, the SEC has proposed an item that will set back good corporate governance.