February 2006
On January 27, 2006, the Securities and Exchange Commission (the “SEC”) published proposed rules that
would:
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Overhaul disclosure requirements for executive
and director compensation, including a new Compensation Discussion and Analysis section modeled after the Management’s Discussion and
Analysis concept;
Reorganize and consolidate the disclosure rules for
related party transactions, director independence
and certain other corporate governance matters;
Amend the disclosure of security ownership of officers and directors to require disclosure of the
number of shares pledged by management; and
Amend Form 8-K to focus current disclosure of
executive compensation arrangements on unquestionably or presumptively material events.
Chairman Cox noted that this is the first time in 14
years that the SEC has undertaken significant revisions
of its disclosure rules regarding executive compensation. Chairman Cox indicated that the SEC wants investors to have better information, including a single
bottom line figure for total annual compensation and a
more accurate representation of perquisites. He also
stressed that the proposed rules are “about wage clarity, not wage controls.” The proposed rules are not
designed to impose salary caps on corporate executives, but rather to improve the disclosure of compensation arrangements. Chairman Cox noted that it will
still be up to the board of directors to decide how
much to pay executives, but that “companies will have
to disclose a clear explanation of how they arrived at
both the amount and the measurement.”
The comment period expires April 10, 2006, and the
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effective date for the final rules will be based on the
date of publication in the Federal Register, as follows:
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Form 10-K: For fiscal years ending 60 days or more
after publication.
Form 8-K: For triggering events that occur 60 days
or more after publication.
Registration Statements: For statements that will
become effective 120 days or more after publication.
Proxy Statements: For statements that will be filed
90 days or more after publication.
Companies will not be expected to restate compensation or related party disclosures for fiscal years for
which they previously applied the current rules.
Most of the new disclosures will be required to be presented in “plain English.”
Executive Compensation
The proposed rules would apply to the principal executive officer, principal financial officer, the three
other highest paid executive officers (measured by
base, bonus and long-term compensation) and all directors. The new disclosures will be required in proxy
statements, registration statements, annual reports and
certain current reports on Form 8-K. The core of the
new compensation disclosure rules is the new
“Compensation Discussion and Analysis” section.
This section addresses the objectives and implementation of executive compensation programs, focusing on
the most important factors underlying compensation
policies and decisions reflected in the tabular data. It
will be followed by more traditional tabular disclosures, organized into three broad categories:
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Compensation over the last three years;
Outstanding equity interests (options, warrants,
SARs, etc.); and
Retirement plans and other post-employment payments and benefits.
In addition, the current Compensation Committee Report and performance graph will be eliminated, and
the proposal includes a requirement to disclose the total compensation and job description (but not the
names) of employees who are not executive officers
but who earn more than the five highest paid executive
officers.
Compensation over the last three years
The principal vehicle for the disclosure of compensation over the last three years (after a phase-in to avoid
restating disclosures properly made in prior years under the current rules) will be a reorganized “ Summary
Compensation Table,” which will be similar to the current table but with additional information:
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A new column for total compensation, which will
include a single bottom line figure for total annual
compensation;
A dollar value for all stock-based awards, including stock and stock options, measured at grant date
fair value (computed pursuant to FAS 123);
The “ All Other Compensation” column will now
include the aggregate increase in actuarial value of
pension plans accrued during the year and all
earnings on deferred compensation that is not taxqualified; and
The threshold for disclosing perquisites will be reduced from $50,000 to $10,000, with interpretive
guidance provided for determining what is a perquisite.
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There will also be two new supplemental tables, a
“ Grants of Performance-Based Awards Table” and a
“ Grants of All Other Equity Awards Table.”
Finally, there will be a separate “ Director Compensation Table” similar to the “ Summary Compensation
Table,” with related narrative to disclose director compensation, covering only the most recent year.
Outstanding equity interests
Two new tables will disclose outstanding equity interests. An “ Outstanding Equity Awards at Fiscal YearEnd Table” will show outstanding awards representing potential amounts that may be received in the future. An “ Option Exercises and Stock Vested Table”
will show amounts realized and vested on equity compensation during the last year.
Retirement plans and other post-employment payments and
benefits
There will be two new tables to disclose retirement
plan and post-employment payments and benefits. A
“ Retirement Plan Potential Annual Payments and
Benefits Table” will disclose annual benefits payable to
each named executive officer. A “ Nonqualified Defined Contribution and Other Deferred Compensation
Plans Table” will disclose year-end balances as well as
executive contributions, company contributions, earnings and withdrawals for the year.
In addition, the proposed rules contemplate disclosure
of payments and benefits, including perquisites, payable upon termination or change in control. Most significantly, the proposed rules would require quantification of these potential payments and benefits, which
is not currently required.
Related Party Transactions
Security Ownership of Officers and Directors
The proposed rules would require that a company disclose its policies and procedures for approving related
party transactions. The categories of related parties
would be expanded slightly, and the threshold amount
for disclosure would be increased from $60,000 to
$120,000. The disclosure requirement for a particular
transaction would be more principles-based, and
would require disclosure if a company is a participant
in a transaction in which a related person has a direct
or indirect material interest.
The proposed rules would require disclosure of the
number of shares pledged as collateral by named executive officers, directors and director nominees, as
well as directors’ qualifying shares (shares required to
be held to meet minimum ownership requirements).
Form 8-K
Director Independence and Other Corporate Governance Matters
The proposed rules would modify Form 8-K to capture
certain employment arrangements and material
amendments thereto for named executive officers. All
Form 8-K disclosure regarding employment arrangements would be consolidated under a single item.
The SEC proposed adding a new Item 407 of Regulation S-K and Regulation S-B, which would:
For the text of the proposed rules, click here:
http://www.sec.gov/rules/proposed/33-8655.pdf
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Require disclosing whether each director and director nominee is independent;
Require descriptions of any relationships not otherwise disclosed that were considered when determining whether someone was independent;
Require disclosure of any audit, nominating and
compensation committee members who are not
independent;
Consolidate certain corporate governance related
disclosure requirements that are currently set forth
in a number of places in the proxy rules and Regulation S-K or Regulation S-B, including the disclosures regarding board meetings and committees,
and specific disclosure about nominating and audit
committees; and
Require disclosure regarding compensation committees and a narrative description of their procedures for determining executive and director compensation.
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For the SEC’s press release in connection with the announcement of the proposed rules, click here:
http://www.sec.gov/news/press/2006-10.htm
For Chairman Cox’s opening statement in connection
with the announcement of the proposed rules, click
here:
http://www.sec.gov/news/speech/spch011706cc.htm
Know-How to Win:
1.
Although it is unlikely that the proposed rules will
apply to the current proxy season, start thinking
about how to comply with this season’s requirements with the new regime in mind, to make the
transition to the new rules less burdensome.
2. Consider what policies and procedures (for both
setting and tracking executive compensation)
should be implemented now to prepare for next
year’s likely disclosure requirements.