Alerts and Updates
SEC Proposes Significant Changes to Executive Compensation Disclosure
February 21, 2006
On January 27, 2006, the Securities and Exchange Commission (SEC) published for comment proposed rules amending the disclosure requirements for executive and director compensation, related party transactions, director independence and other corporate governance matters and security ownership of officers and directors. The proposed rules would affect disclosure in proxy and information statements, periodic reports and registration statements. The proposals represent the first significant revision of the executive disclosure rules in 14 years. The proposals also would modify the current reporting requirements of Form 8-K regarding compensation arrangements. Comments on the proposed rules are due by April 10, 2006, and the SEC has proposed that the new rules would be effective for proxy statements filed after 90 days following their adoption.
This Alert presents a brief overview of the proposed rules, followed by a more detailed discussion of the proposals.
Goals of the New Rules
The proposed rules seek to require companies to divulge significantly more information about the total compensation, retirement benefits and perquisites of each of the company's five highest-paid executives. The goal is to elicit clearer and more complete and transparent disclosure of compensation of the principal executive officer, principal financial officer, the three other highest-paid executives and the directors.
Overview
Executive Compensation
The proposed rules would require that the disclosures regarding executive compensation begin with a narrative overview of the company's executive compensation policies. This "Compensation Discussion and Analysis" (CD&A) is similar in some respects to the Overview section of Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) and would replace the current report of the compensation committee. The intent of the CD&A is to provide an overview and context for the more detailed disclosures that follow it, addressing matters such as the company's policies on allocating compensation between cash and non-cash compensation, and among different forms of non-cash compensation.
Following the CD&A, detailed discussion of executive compensation would be organized into three broad categories:
- compensation over the last three years;
- holdings of equity-related interests received as compensation that are the source of future gains; and
- retirement plans and other post-employment payments and benefits.
Three-Year Compensation
Disclosure of compensation over the last three fiscal years would begin with a reorganized Summary Compensation Table. As under current rules, the Summary Compensation Table would disclose the specific amounts of each type of compensation paid to the "Named Executive Officers" in each of those three years. However, the SEC has proposed several significant changes to the table and related disclosures, including:
- the "Named Executive Officers" would now include any person who served as principal financial officer at any time during the year. As under current rules, any person who served as the company's principal executive officer also would be a Named Executive Officer. In addition, the company's three most highly compensated executive officers, other than the principal executive officer and principal financial officer, would be Named Executive Officers, except that no disclosure would be required for any such officer whose total compensation (not just salary and bonus, as under current rules) did not exceed $100,000.
- all items of compensation would be shown in dollar amounts. Non-cash compensation, including options and other equity-based compensation, would be valued at its fair value at date of grant, generally in the same manner as it is valued for financial reporting purposes under recently adopted accounting rules.
- the table would include a "Total" column, adding up the dollar amounts in the other columns.
- the threshold for disclosing perquisites would be reduced to $10,000. The proposing release includes certain guidance for determining what qualifies as a perquisite.
Disclosure of compensation over the last three years would continue with two additional tables, one disclosing grants of equity compensation, such as options and restricted stock, and a second for grants of other types of performance-based awards. Each of the three tables would be followed by narrative discussion, as necessary to enable investors to understand the information in the tables. This would include discussion of the material terms of employment agreements; description of any repricing of options or other equity interests; and material terms of equity awards.
In a significant departure from current rules, companies would be required to disclose the total compensation of up to three employees who are not executive officers and whose total compensation exceeded that of the Named Executive Officers. The disclosure would include a description of the individuals' jobs or positions, but would not need to name them.
Compensation-Related Equity Holding
Disclosure regarding the Named Executive Officers' outstanding equity interests would include:
- an Outstanding Equity Awards at Fiscal Year-End Table, showing the outstanding awards representing potential amounts that may be received in the future; and
- an Option Exercises and Stock Vested Table, showing amounts realized on equity compensation during the last year.
Retirement Benefits and Other Post-Employment Compensation
The proposed rules would create two new tables for retirement benefits:
- a Retirement Plan Potential Annual Payments and Benefits Table, disclosing estimated annual benefits payable to each Named Executive Officer at retirement; and
- a Nonqualified Defined Contribution and Other Deferred Compensation Plans Table, disclosing for such plans the year-end balance and the executive contributions, company contributions, earnings and withdrawals for the year.
In narrative discussion, the company would disclose payments the company is obligated to make to the Named Executive Officers on termination, change in control or change in position, including the estimated amounts payable.
Director Compensation
The proposed rules would require a new table of compensation of directors, similar to the Summary Compensation Table, and related narrative, disclosing director compensation for the last year.
Related Person Transactions
The proposals update, clarify and expand existing disclosure provisions regarding related person transactions. Principal changes include a requirement to disclose the company's policies and procedures for approving related party transactions, an expansion of the categories of related persons and a change in the threshold for disclosure from $60,000 to $120,000. The requirement to disclose these transactions would also be more principles-based, requiring disclosure when the company is a participant in a transaction in which a related person has a direct or indirect material interest, but without the detailed, bright line tests currently included in the rules.
Director Independence and Other Corporate Governance Matters
A proposed new item (Item 407 of Regulations S-K and S-B) would require:
- disclosure of whether each director and director nominee is independent;
- a description of any relationships not otherwise disclosed that were considered when determining whether each director and director nominee is independent; and
- disclosure of any audit, nominating or compensation committee members who are not independent (under the in some cases stricter definitions applicable to such committees).
Proposed Item 407 also consolidates corporate governance disclosure requirements currently set forth in a number of places in the proxy rules and Regulations S-K or S-B. This includes disclosure regarding board meetings and committees, and specific disclosure about nominating and audit committees. Proposed Item 407 also requires disclosure of members of the compensation committees and a narrative description of the committee's procedures for determining executive and director compensation.
Security Ownership of Officers and Directors
The proposals would require disclosure of the number of shares of the company's stock that have been pledged by management as collateral for loans. The SEC is concerned that security pledges could potentially influence management's performance and decisions.
Form 8-K
The SEC has observed (as many companies have complained) that the recent revisions to Form 8-K have resulted in a substantial expansion of the number of filings relating to executive compensation, including filings that go beyond the level of materiality intended for Form 8-K. Accordingly, the SEC has proposed to narrow the requirements of Form 8-K applicable to executive compensation and to consolidate all such disclosures under a single item.
Plain English Disclosure
The proposals require companies to furnish executive compensation information using plain English principles of organization, language and design.
Actions to Consider Now
While the SEC's proposals are subject to a 60-day comment period and may be revised before adoption, the SEC staff has, in public speeches, encouraged companies to adopt the new disclosure proposals, even before the regulations are officially adopted. Clients have asked our advice regarding compliance with the new rules prior to their final adoption. While each company's circumstances will warrant independent consideration of an early adoption of these proposed rules, public companies should consider that compliance with the proposed rules will not relieve a company from complying with existing disclosure requirements. Early adoption may require two sets of compensation disclosures. Further, if the proposals are substantively changed during the comment period, it is possible that companies that comply with the proposed disclosure requirements will make disclosures that are different than those required in subsequent years, or possibly not required at all.
Companies should note that the interpretive guidance concerning what constitutes a perquisite applies currently regardless of when, or in what form, the proposed rules are adopted. Accordingly, while existing rules continue to apply (including rules relating to threshold amounts), companies should consider the interpretive guidance concerning perquisites when preparing this year's proxy disclosure.
Boards and compensation committees should continue to monitor these proposed rules and consider their implications in establishing and modifying executive compensation plans. Compensation plans should reflect the business goals of the enterprise, and boards should be mindful of the goals of the disclosure requirements. Even before these proposals become final, they provide a valuable insight to the importance that the SEC places on compensation disclosures and companies should re-evaluate their executive compensation disclosure in their proxy and Form 8-K filings to provide stockholders with comprehensive, transparent explanations of the goals and specific details of the company's compensation plans.
Read a more detailed description of the proposals.
For Further Information
If you have any questions regarding the proposed rules, including how they may affect your company, or would like to consider submitting comments on the proposals, please contact one of the attorneys of the Securities Law Practice Group or the lawyer in the firm with whom you are regularly in contact.
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.
