The SEC has amended its disclosure rules to require, among other matters, a discussion about a company’s compensation policies and practices for all employees if they create risks that are “reasonably likely” to have a material adverse effect on the company. [1] Prior SEC guidance, to which the SEC referred in adopting the amendments, indicates that the “reasonably likely” threshold is higher than “possible” but lower than “more likely than not.”

We are skeptical that any compensation committee knowingly approves compensation programs and arrangements that place the company at material risk, and insofar as the standard imports a “risk factor”-type threshold, we question whether it will elicit meaningful disclosure. That said, a conclusion that the disclosure trigger is not met necessarily rests on an assessment of the balance of risk and reward implied by the company’s compensation program design and incentive targets, taken as a whole. As with many SEC rules in the post-SOX era, process will be key. Because the compensation committee plays a central role in that process, we suggest below practical considerations relevant to its deliberations. We also note that most compensation committees do not now routinely review compensation arrangements for rank and file employees. A predicate for analyzing the disclosure question will therefore be an inventory and review of the operation of compensation programs for all employees, which should be undertaken immediately in light of the effective date of the rules. [2]

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