The Advisors' Blog

With the number of subsections that have been tacked onto Item 402 through the years, it can be easy to forget Item 402(s) as you’re wrapping up your proxy statement. That Item says that to the extent that risks arising from a company’s compensation policies & practices – for executives and/or other employees – are reasonably likely to have a material adverse effect on the company, the company must discuss its compensation policies & practices as they relate to risk management practices and risk-taking incentives.

Whether or not a company determines that there is a material risk that triggers this public disclosure, it’s important to conduct and document the assessment that led to the conclusion. That helps those of us reviewing disclosures ensure there’s support for what the company does – or doesn’t – say, and if something goes sideways in the future, it can help the company avoid or defend against claims that this disclosure was improperly omitted or inaccurate. This ClearBridge memo lays out the four key steps for conducting the assessment:

1. Identify compensation program features (“compensation principles”) that either can encourage excessive risk-taking or can mitigate against excessive risk-taking (see next page for examples)

2. Review all employee compensation plans and policies (not just executive officer plans and policies; should also include sales/commission/other plans)

3. Review company’s business risks (e.g., risk factors disclosed in company’s 10-K) and identify compensation principles related to these business risks

4. Assess the company’s business risk and compensation program relative to compensation principles

5. Determine potential implications for the compensation program going forward

The memo goes on to provide examples of practices that may encourage more risk-taking. The SEC rules don’t forbid companies from having risk-promoting incentives, but you would need to consider whether the compensation-risks are reasonably likely to have a material adverse effect. If the answer to that question is “yes,” you then need to disclose how you manage those risks.

Also see Meredith’s blog last fall, and our “Risk Assessments” Practice Area, for more guidance & resources on this topic.

– Liz Dunshee