By James Hamilton, J.D., LL.M.
The retail disclosure system has devolved into a self-serving exercise for issuers, underwriters, and their lawyers, noted SEC Chair Christopher Cox, and nowhere is this more evident than in the new Compensation Discussion & Analysis sections being filed with the Commission. After reviewing the first of this year's crop of proxy filings containing the CD&A, he noted, ``alarm bells are ringing’’ as the staff is seeing examples of over-lawyering that are leading to 30 to 40 page long executive compensation sections in proxy statements. His remarks were made at a recent corporate governance seminar at the USC Marshall School of Business.
The SEC is disappointed with the lack of clarity in much of the narrative disclosure that has been filed so far. Based on the early returns, he noted, the average CD&A section is not anywhere close to plain English. In fact, according to objective third-party testing, he said, most of it is as ``tough to read as a Ph.D. dissertation.’’
This lack of clarity is particularly troubling since the CD&A is the centerpiece of the SEC’s new executive compensation disclosure regime. The CD&A is designed to be a principles-based narrative overview explaining the policies and material elements related to the company’s executive officer compensation.
Since mandating the CD&A as part of its comprehensive overhaul of executive compensation disclosure, the SEC has been adamant that the CD&A be written in Plain English. But a private sector investor relations firm analyzed the CD&As of forty companies and determined that they all fell far short of accepted standards of readability. In fact, related Mr. Cox, the firm found that most of the disclosure documents failed even to meet the readability standards that states require for insurance forms. Among other things, the CD&A disclosures were verbose and fell well below a Plain English threshold. While the SEC was expecting that the CD&A would be just a few pages long, the median length for the CD&As came in at 5,472 words, with the longest at more than 13,500 words.
This private analysis, in addition to the SEC’s own qualitative review of the proxy statements, indicates that there is a long way to go before legalese and jargon are truly replaced by plain English. The SEC believes that many companies are letting lawyers have the final say on the CD&A. As the firm that undertook this study pointed out, many of the problems could easily have been fixed in just a few hours by a qualified copy editor.
Even more, the SEC intends to employ readability metrics tools to judge the level of compliance with the Plain English rules. These tools, similar to the Black-Scholes model for stock options, measure the readability of English prose based on sentence length and the number of complex words. This is one indication that the SEC is ``dead serious’’ about shedding seventy years of accumulated bad habits in writing, said Chairman Cox.
The CD&A is a brand new creation, he pleaded, so there is no tested boilerplate out there to be picked up and used. Similarly, there are no judicial or regulatory precedents to mark up and reuse. Thus, there is no reason for a company to match up its disclosure to that of its peers or competitors. There are no magic words to recite from court opinions and SEC interpretations. Thus, he urged every company to take this opportunity to start CD&A with a clean slate and plainly tell their executive compensation story to investors.