Geoffrey Edwards, Associate General Counsel and Assistant Secretary, Wal-Mart, talks us through the process he put together to prepare for the SEC's overhaul of executive compensation requirements and Chuck Loring, SVP, Director, Executive Compensation, Wachovia Corporation, discusses the new proxy reporting requirements from the perspective of a major financial services firm.
At the time of speaking, Wal-Mart had not yet filed its proxy statement, so Edwards was deep in the process of putting an executive compensation disclosure process together and trying to resolve some of the questions related to the new rules. “I joined Wal-Mart in July 2006,” he says. “Since then I've spent an increasing amount of time working with the new rules and preparing for new disclosures to the point that for the last 1-2 months that's all I've been doing and it's all I will be doing until after our proxy is filed.” Loring, who has also recently been keenly focused on good governance, offered Wachovia's perspective on some of the issues they faced and how they were resolved.
The SEC published its new rules in August, 2006, (applying to disclosures for FYE 12/15/06 and later) which were subsequently amended on December of the same year. This meant that new rules had to be adopted in the middle of the year that were then applied to executive compensation for that same year. For Edwards, the lack of lead time meant that organizations had to expend a lot of time and effort trying to understand how the new rules applied to them, “none of our compensation committees knew what the rules were going to look like, and even after the rules were adopted they were amended after they were already in effect.” In fact the SEC introduced significant changes to deferred compensation plans and stock option expensing reporting requirements. The changes had a significant impact on the reporting of total compensation, a key focus for many reporters, which has led to some problems: “There has been press on a couple of companies who have come up with negative compensation figures for some executives because of the way they have applied the technical rules for how equity is valued, resulting in an unindented anomaly,” says Edwards. Since December there has been a limited amount of interpretation of the new rules published by the SEC. Meaning, according to Edwards, that “folks are wrestling with the most transparent way to make certain disclosures.”
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In response to these challenges Wal-Mart's first response was to start educating its associates by showing what last years compensation would have looked like if the rules were in place then, “we took fiscal 2006 compensation results (calendar year 2005 and January 2006) and prepared a mock up to educate our executives, compensation committee and corporate communications department to show them how the new rules would impact compensation disclosure,” explains Edwards. The focus ramped up in October when John White, the Head of Corporate Finance at the SEC, made a speech to a group of CFOs where he emphasized in no uncertain terms their personal responsibility and the the need for them to be involved in the process of putting together compensation disclosure and making sure that there were controls around the reporting process. “Wal-Mart's CFO happened to be at this talk and it caught his attention,” says Edwards.
The increased focus on executive compensation disclosure and awareness which the new rules have established has made others sit up and take note. Most companies have put compensation disclosures in their proxy statements for a long time and CEOs and CFOs certify that they have put together an effective system of controls and procedures to ensure the disclosure is accurate and timely. But now, as the disclosure is a lot more detailed companies are trying to develop best practices. “What we have done is to go back and have a fresh look at the controls and procedures surrounding executive compensation disclosure so that they are as good as they can be,” says Edwards.
The process, at Wal-Mart, required a wide commitment across the entire organization, explains Edwards. “We looked at all the requirements to be disclosed and we broke it out into 79 pieces of information that we needed to collect from our business partners all over the country. With that we built a matrix where we identified the rule requiring the piece of information and described in terms that were precise and understandable the information we were looking for, regarding for example an equity grant or bonus programs, then we built a schedule with due dates and consulted with partners to see how soon they could get the information back to us. We also met with the VP's in charge of each department to explain what we needed and why we were doing this.”
“We also got our compensation committee involved very early on,” says Edwards.“We gave our compensation committee a presentation in early November 2006 where we described the new rules and gave them an overview of the processes we were putting together.”
Edwards had the full support of his CFO and also involved Wal-Mart's audit department to ensure the process he built could be audited. “We developed certification forms modelled on internal control forms for Sarbanes Oxely 404 compliance.” The certification forms required the responsible parties in the appropriate department to describe the process that they had put in place to make sure the information provided was correct. These certifications had to be signed by the responsible process owner, as well as reviewed and signed by the VP level officer who was ultimately responsible for the area concerned. The whole process required involvement from compensation consultants, the compensation committee, internal and external auditors, the retirement and savings department, and people from payroll, tax and benefits. “Its really taken a lot of focus from a lot of folks across the company,” says Edwards.
“About 2 years ago our CEO asked me if we could add a column to the summary compensation table to show total compensation,” comments Loring. “I have to admit my first thought was why would we do that when it isn't required and our competitors aren't doing it.”
In fact, the point Thompson was trying to make was that the total compensation information was available on the proxy statement anyway so why not make it easier to understand. “Then we would hopefully minimize misrepresentation by the press,” says Loring. Under the new rules the SEC is applying this principal universally, which is part of an attempt to bring more clarity to executive compensation practice.
According to Loring there are a number of significant changes in the new rules, including: a compensation discussion and analysis section (CD&A); an expanded summary compensation table; and additional disclosure on equity, retirement and other benefits. He comments: “The most significant of these, to me, is the compensation discussion and analysis section which requires a much more comprehensive disclosure of the company's compensation strategy than the old compensation committee report.”
The CD&A section requires a more explicit description of the key elements of compensation strategy and includes disclosing things like the sources used to benchmark compensation, the peers used in benchmarking pay or performance, the role of other executives in the process, and how the process might differ from that used for the CEO and other executives.
In his presentation Loring described how Wachovia looked at these changes and prepared for its proxy this year. To begin with Loring noted that the executive compensation section was almost 4 times longer (from 13 pages to 47) than under the old proxy. While the new rules attempt to provide clarity Loring thinks the significant increase in information disclosed can lead to some confusion. “We had originally considered including a compensation history from prior years even though the rules didn't require it, however, the last minute changes on December 22 to disclosing stock values effectively made it very difficult for us to compare prior year information so we abandoned that approach.”
In an attempt to release the clearest possible picture of executive compensation Wachovia provided a number of additional pieces of data, including information on expenses based on prior year awards and a non-qualified deferred compensation table, which, Loring says, gives a more complete disclosure of contributions, earnings and payments made during the year. The new CD&A, which provides very specific information on benchmarks for compensation, performance goals, compensation targets and how performance determines the pay used in compensation, was also augmented. “We decided to add another section on CEO compensation.” says Loring. “Where we discuss compensation strategy for the CEO and how his pay was determined for the last 3 years. We felt this was a section that shareholders and reporters could go to and understand the thinking of our compensation committee. It gives a historical view of our CEOs compensation and performance and a clearer picture of what he received for each years performance.”