Issue link: https://digital.shearman.com/i/1512772
Shearman & Sterling LLP 31 | Executive Officer Departures: Is your Disclosure Adequate? 2 The portions of the SEC's order in this action regarding violations by the CEO are not the focus of this article. officer's departure, Item 402 is, overarchingly, a principles-based reporting regime that requires disclosure of all material elements of the company's compensation program and why the company chooses to pay each compensation element. This "why" disclosure has not historically been viewed as an obligation of a company to defend its characterization of a termination as one that should result in severance or other termination compensation. However, in light of recent SEC action, there could be increasing pressure on companies to explain the appropriateness of severance payments in the context of a departure, particularly in situations where facts may suggest the existence of elements that could have resulted in a for cause termination. SEC Action Against McDonald's In November of 2019, McDonald's terminated the employment of its CEO and, as required, filed a Form 8-K within four business days of the termination. In addition to announcing the CEO's departure (without specifying a reason for the departure), the Form 8-K stated that the CEO "will be eligible for the severance benefits contemplated by the company's benefit plans upon a termination of employment." Although the Form 8-K was silent as to the reason for the CEO's departure, the company included as an exhibit to the Form 8-K a press release that stated that the termination of employment followed the board's determination that the CEO had violated company policy by engaging in a consensual relationship with another McDonald's employee. McDonald's later filed its 2020 annual proxy statement in April of 2020, which stated that the same CEO was terminated "without cause" and characterized the severance benefits he received as an entitlement. In January 2023, the SEC brought an enforcement action against McDonald's for allegedly violating the Exchange Act with respect to the company's proxy disclosure surrounding these severance payments and against the CEO related to alleged untrue statements he made during an internal investigation of the company. 2 In its order accepting settlements by the company and the CEO and imposing remedial sanctions and a cease-and-desist order against the company and the CEO in connection with the action, the SEC noted that Item 402(b) of Regulation S-K requires a company to "explain all material elements of the registrant's compensation of the named executive officers", including "factors considered in decisions to increase or decrease compensation materially." In the SEC's view, McDonald's violated Section 14(a) of the Exchange Act by failing to expressly disclose that it exercised discretion in treating the CEO's termination of employment as one "without cause" under the terms of its compensation plan documents. The SEC's decision was not unanimous. Both Commissioners Peirce and Uyeda issued a statement opposing the SEC's action, which they stated goes beyond the established practice of executive compensation disclosure that has developed since the current version of Item 402(b) was promulgated in 2006. They wrote, "[s]uch 'hiring and firing discussion and analysis' is beyond the rule's scope." Companies, according to the two dissenting Commissioners, should not have to disclose the underlying reasons why the decision was made to terminate an executive officer with or without cause. The question that arises from this decision is whether the SEC intended to suggest that where facts exist to support a for cause termination, a company must publicly explain why it moved forward with a termination without cause and the payment of compensation provided in connection with such type of termination. Or, in the alternative, is the SEC suggesting that a decision to pay compensation consistent with a without cause termination was an exercise of discretion requiring explanation and express disclosure under Item 402 of Regulation S-K because, in fact, the CEO was terminated for cause. Notably, as described above, McDonald's issued a press release highlighting that the CEO's termination followed a violation of company policy.