Let's talk about cash

Sooner or later everything finds its way north. That is the attitude of many people in Canada and it is certainly true in terms of new executive compensation disclosure rules. In the first major change to compensation disclosure requirements since 1994, the Canadian Securities Administrators (CSA) has published changes to rule 51-102 (section F6). This rule governs what a public company must disclose in its annual proxy filings.

The new rules, which were finalized in September 2008 and took effect as of December 31, are largely reminiscent of the expanded compensation discussion and analysis (CD&A) requirements introduced by the SEC in the US in 2006.

Most shareholder groups laud the new legislation and most companies have viewed it as inevitable. Despite seeing the writing on the wall, a lot of Canadian companies were not completely ready and have been struggling with the new rules. While much guidance can be garnered from the experience of US companies, there are some important differences – and the difficulty of the task should not be underestimated, especially as this will be the first year the vast majority of Canadian companies will be doing it.

‘It is more time-consuming than you think,’ explains Catherine Gordon, president of SimpleLogic. Ensuring the 2008 CD&A is complete, compliant and clear is a challenge for every company, no matter how simple or complicated its compensation practices are.

‘The new Form 51-102F6 requires companies to disclose all compensation awarded to certain executive officers and directors and to provide this disclosure in a new format,’ wrote the CSA when introducing the new rules. It went on to explain that the location for disclosure remains unchanged: the management proxy circular.

Venture issuers are also subject to all the new disclosure items, with the exception of the need to provide a share performance graph. Additionally, unlike in the US, Canada does not require CEO/CFO certification of the CD&A, nor does the CD&A need to be approved by the compensation committee.

‘The level of involvement of the board of directors or a compensation committee in the preparation of the CD&A is a matter for each company to determine based on its own circumstances,’ says the CSA

While the new rules are of primary concern to all Canadian public issuers, some companies were already in compliance because Canadian issuers reporting in the US are exempt if they comply with US domestic compensation disclosure requirements.

Companies need to ask themselves a number of questions when compiling their CD&A, the most important of which is whether it tells the full story. As US companies discovered with their first CD&As in 2007, if there is an element they’re uncomfortable with or do not wish to disclose, it probably means it is a problem area and exactly the one on which shareholders will focus. Getting disclosure layout right is only the first step. If pay practices are out of alignment with performance, even the best disclosure language will not get you out of trouble.

Tips for preparing CD&A disclosure
Mercer, the global consulting firm, suggests these focus areas for companies wrestling with how best to write the CD&A:

• Start with an executive summary. Provide insight into the company’s rationale for its compensation decisions and highlight specific events that influenced those decisions. These may include changes in key executive personnel or a significant merger or acquisition. For 2009 it is worth including a discussion of how current market conditions affect compensation structures.
• Focus on analysis over process. Disclose the basis and context for granting different types and amounts of compensation and discuss the factors the compensation committee considered in approving each element of pay. In lieu of boilerplate discussions of individual performance, a more specific analysis of how and why the company considered individual performance to determine executive pay should be provided.
• Present pay elements in a table. A table is a concise way to summarize the various elements of pay provided to executives, such as base salary, annual and long-term incentives and benefit plans. A more detailed description of the different pay elements would follow in narrative form. The table could include columns showing individual compensation elements, objectives and key features.
• Demonstrate pay mix using graphics. A pie chart or graph is an easy way to show the percentage of each executive’s compensation that is performance-based and at-risk, to demonstrate the pay-for-performance link.
• Draw peer group comparisons. The compensation discussion and analysis must disclose any benchmarks used for setting compensation and explain the components of the benchmark, including a complete list of the companies in the peer group and the selection criteria. The various characteristics might include industry, revenue size, net income, market capitalization, or number of employees.
• Disclose performance goals and/or history of goal achievement. Disclose specific quantitative and qualitative performance-related factors for incentive-based compensation plans if they are ‘significant.’ Performance targets would generally be considered significant for completed performance periods but, arguably, future or current period targets may not be considered significant and, thus, may not need to be disclosed.
• Highlight important compensation policies. Discuss important policies on compensation issues to show a commitment to aligning management’s interests with those of shareholders, such as share ownership guidelines, anti-hedging policies, holding periods, or recovery (clawback) policies.
• Describe new actions, decisions or policies. This disclosure provides an opportunity to spotlight changes that demonstrate an increased commitment to pay-for-performance principles, enhanced alignment of management and shareholder interests, and improved corporate governance and pay policies
• Write in clear, concise language. Avoid legal and financial boilerplate. Short paragraphs and sentences can vastly improve a complicated explanation of dense material. Also, tables and graphics, as well as headings and bulleted lists, will add to the clarity and transparency of the disclosure and help readers to understand and appreciate the rationale behind compensation decisions.

Most importantly it is about telling your compensation story as well as possible. One problem that US firms continue to encounter is trying to walk the line between complying with the legal aspects of the CD&A – it is after all a regulatory filing – and writing in a manner that can be easily digested and understood. There is no easy solution but getting shareholder feedback beforehand, involving IR and compliance teams and working with legal, will go a long way to achieving the best results possible for the company and investors.