October 17, 2006
The SEC’s New Executive
Compensation Rules
or
What is a PFO and Why Should I
Care?
FEI Briefing
Christopher McGee
Washington, DC
The Process and the Substance of Compensation
Disclosure Have Changed

Full disclosure means full disclosure
– Not business as usual!
– “All compensation, earned or paid, from all sources, for all
services.”

Each public company must implement a coordinated information
gathering and analysis effort

The Compensation Committee must participate in the effort at each
stage
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The New Rules Have Made Fundamental Changes
to the Substance of Compensation Disclosure

Full Disclosure Principle

Plain English

Significant Changes to Summary Compensation Table

New Disclosure Tables and Accompanying Narrative Disclosure

Compensation Discussion & Analysis

Related Person Transaction Disclosure Changes

Form 8-K Changes
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What is Different?
Named Executive Officers

Anyone who at any time during the previous fiscal year served as:
– Principal executive officer (PEO)
– Principal financial officer (PFO)

Three most highly-compensated executive officers (other than PEO
and PFO) who were serving as executive officers as of the last day of
the previous fiscal year
– Based on total compensation excluding pension values and
NQDC earnings
– Officer is not an NEO if his or her total compensation does
not exceed $100,000

Up to two additional individuals who would have been in the top three
except they were no longer serving as executive officers at end of last
fiscal year
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Summary Compensation Table Changes

The Summary Compensation Tables have been materially changed in
both form and substance (see sample table in Appendix).

Data that has been historically included (Base, Bonus, LTI) will still be
included but with changed methodologies for reporting:
– Bonuses will be split between guaranteed and performance based
– LTI will split equity grants and option (or option like) awards and
the valuation of the awards is to mirror the expensed value (i.e.
Black Scholes) for equity.


Definition of Perquisites reduced to $10k and will also include “all
other forms of compensation”
Additional data will be required that has never been required. Includes
the change in value of Pension benefits and the increase in excess of
market returns, on deferred compensation.
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New Supplemental Tables
There are 6 new tables that are required for all filers. Details for each
table and the associated narratives are included in the Appendix.
The 6 new tables are:

Grants of Plan-Based Awards Table

Outstanding Equity Awards at Fiscal Year-End Table

Option Exercise and Stock Vested Table

Pension Benefits Table

Nonqualified Deferred Compensation Table

Director Compensation Table
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Narratives
The rules require Narratives to accompany all tables. Details on the
required narratives for each table are included in the appendix.
The key theme of the narrative requirements are that they must explain
in sufficient detail:

Foundation for Salary and relative target to market

All methodologies, metrics and outcomes that drive awards of
bonuses and LTI awards.

Rationale for benefits and perquisites.
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Potential Payments upon Termination of
Employment or Change-in-Control Summary
.The description (no table required) must include the following detail:
– Specific circumstances that would trigger payment or other benefits
– Estimated payments and benefits that would be provided in each covered
circumstance, whether it would or could be in lump sum or annual,
disclosing the duration and by whom it would be provided
– Factors used to determine appropriate payment and benefit levels
– Any material conditions or obligations applicable to receipt of payments or
benefits
– Quantification of the benefits and payments in each covered circumstance
(even if uncertainties exist), calculated by applying the following
assumptions:
The triggering event took place on the last business day of the last
fiscal year
The price per share of the company’s securities is the closing market
price as of that date


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Compensation Disclosure and Analysis

Replaces Board Compensation Committee Report (see appendix for
more detail)
– Considered “filed” with, rather than “furnished” to, the SEC
– See new Compensation Committee Report requirement

Intended to provide overview of executive compensation program
– Summary of each program element
– Context for tabular and supplemental narrative disclosure


Company presentation – of compensation committee’s views of
executive compensation program
Focus in on “analysis” of compensation policies and decisions
– Less a recitation of the facts and more an explanation of what is
actually going on
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New Compensation Committee Report

New Compensation Committee Report
– Presented over names of compensation committee members
– Intended to ensure committee is actively involved in preparing
CD&A
– Resembles current Audit Committee Report that is required in
proxy statement

Must state that committee has reviewed and discussed CD&A
with management and recommended that report be included in
proxy statement and annual report on Form 10-K
– Unlike CD&A, considered “furnished” to SEC, so does not carry
liability implications of CD&A
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New Compensation Committee Report
(continued)

Separate narrative disclosure regarding compensation committee structure
and operation
– Comparable to current audit and nominating committee disclosure

Specific disclosure related to executive and director compensation:
– Scope of committee’s authority
– Extent of ability to delegate authority
– Charter (must provide website link or attach to proxy statement every
three years)
– Role of any executive officers in determining or recommending executive
or director compensation
– Role of consultant in determining or recommending executive or director
compensation, identifying consultant, stating whether engaged by
committee, and describing nature of assignment and material instructions
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Appendix
Changes to Summary Compensation Table
• All compensation disclosed in
dollars ($)
• Stock-related awards with optionlike features
• Valuation based on grant date fair
value (FAS 123R)
Name &
Principal
Position
• Only includes discretionary and
guaranteed amounts
• Represents total of all other columns in table
• Total excluding pension values and NQDC
earnings determines officers to include
Summary Compensation Table
(values in 000s)
Year
Salary
($)
Bonus
($)
Stock
Awards
($)
Option
Awards
($)
Non-Equity
Incentive Plan
Compensation
($)
Change in
Pension
Value and
NQDC
Earnings
($)
All Other
Compensation
($)
Total
($)
PEO
PFO
A
B
• Value of all other incentive
awards earned in fiscal year
(includes most annual
incentives)
• Awards where performance
measure(s) not share price
and not settled in equity
• Grant details covered in
supplemental table
C
• Stock-related awards in year grant made that derive value from equity
value, without option-like features
• Valuation based on grant date fair value (FAS 123R)
• Include awards with performance-based conditions
• Earnings not disclosable if factored into fair value
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• Annual change in actuarial present value of accumulated defined
benefit pension plans (including unvested benefits)
• Above-market or preferential earnings on nonqualified deferred
compensation
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SCT – All Other Compensation

“All Other Compensation” column will include:
– Perquisites and other personal benefits
– Tax “gross-ups” and reimbursements
– Discount stock purchases (unless arrangement is broadly
available)
– Amounts paid or accrued under severance and change-in-control
arrangements
– Company contributions to defined contribution plans (but not
earnings)
– Value of insurance premiums paid by company for NEO life
insurance
– Dollar value of dividends or earnings not factored into award fair
value
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SCT – All Other Compensation – Perquisites


Perquisite disclosure requirements
– If aggregate value is $10,000 or more, must disclose/identify each
perquisite
– If individual perquisite has value in excess of greater of $25,000 or 10% of
total perquisites, must quantify and disclose value
“Perquisites” not defined - instead apply two-step analytical framework:
– An item is not a perquisite if it is “integrally and directly related to the
performance of the executive’s duties”
– Doesn’t cover items that merely facilitate job performance
– An item is a perquisite if it confers a “direct or indirect benefit that has a
personal aspect,” without regard to whether it may be provided for some
business reason or for the convenience of the company
– Item not covered if generally available on a non-discriminatory basis to all
employees
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SCT – Narrative Disclosure
Following the tabular disclosure, a company must provide a narrative
description of any material factors necessary to understand the
information disclosed in the table, for example:
– A description of the material terms in the NEOs’ employment
agreements
– Disclosure of repricings or other material modifications of
outstanding awards
– An explanation of the amount of salary and bonus in proportion to
total compensation
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Grants of Plan-Based Awards Table
• Grants made during last completed fiscal year
• Estimated future payouts for both equity and non-equity
incentive plans
• Separate disclosure for each award
Grants of Plan-Based Awards
Estimated Future Payouts Under NonEquity Incentive Plan Awards
Name
• Additional
“Approval
Date”
column
PEO
required if
differs
PFO
from grant
date
Estimated Future Payouts Under
Equity Incentive Plan Awards
Grant Date
Threshold
($)
Target
($)
Maximum
($)
Threshold
(#)
Target
(#)
Maximum
(#)
All Other
Stock
Awards:
Number of
Shares of
Stock or Units
(#)
All Other Option
Awards: Number
of Securities
Underlying
Options
(#)
Exercise or
Base Price of
Option
Awards ($/Sh)
A
• If the per-share exercise price of options is less than
closing market price on grant date, additional column
required showing closing market price on grant date;
must also add footnote explaining pricing
methodology
B
C
• If the award provides only for a single estimated payout, that
amount should be reported as target
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Plan – Based Awards Narrative
The narrative disclosure following this table must describe the terms of
the disclosed awards, for example:
– a general description of the formula or criteria to be applied in
determining the amounts payable
– Vesting schedule
– Performance-based conditions
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Outstanding Equity Awards at Fiscal Year-End
Table
• All outstanding grants at fiscal year end
• Grant-by grant disclosure for each option
• Unrealized option gain no longer disclosed
• Based on achieving threshold
performance unless prior year’s
performance was higher
Outstanding Equity Awards at Fiscal Year-End
Option Awards
Name
Number of
Securities
Underlying
Unexercised
Options
(# Exer)
Number of
Securities
Underlying
Unexercised
Options
(# Unexer)
Equity Incentive
Plan Awards:
Number of
Securities
Underlying
Unexercised
Unearned Options
(#)
Stock Awards
Option
Exercise
Price
($)
Option
Expiration
Date
Number of
Shares or
Units of
Stock That
Have Not
Vested
(#)
Market
Value of
Shares or
Units of
Stock That
Have Not
Vested
($)
Equity Incentive
Plan Awards:
Number of
Unearned Shares,
Units or Other
Rights That Have
Not Vested
(#)
Equity Incentive Plan
Awards: Market or
Payout Value of
Unearned Shares, Units
or Other Rights That
Have Not Vested
($)
PEO
PFO
A
• Vesting dates disclosed in footnote
• Individual exercise price and
expiration dates must be provided for
each award
B
C
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Option Exercise and Stock Vested Table
• Number of shares acquired through exercise
(options) or vesting (stock)
• Value realized at time of exercise (spread) or vesting
(share price)
Option Exercises and Stock Vested
Option Awards
Name & Principal Position
Number of Shares Acquired
on Exercise
(#)
Stock Awards
Value Realized on
Exercise
($)
Number of Shares Acquired
on Vesting
(#)
Value Realized on Vesting
($)
PEO
PFO
A
B
C
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Pension Benefits Table
• Must add footnote if credited
service and actual years of
service differ, and quantify
difference and resulting benefit
augmentation
Name
• Replaces current Pension Plan Table
Pension Benefits
Plan Name
Number of Years Credited
Service
(#)
Present Value of
Accumulated Benefit
($)
Payments During Last
Fiscal Year
($)
PEO
PFO
A
B
C
• Separate disclosure for each plan
• Plans include: tax qualified defined benefit plans, SERPs, cash
balance plans
• Excludes defined contribution plans (next table)
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• Actuarial present value of accumulated
benefit under the plan
• Retirement age assumed to be
“normal” age as defined in the plan, or
earliest unreduced age if none
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Nonqualified Deferred Compensation Table
• Must disclose in footnote contributions, earnings, and
balance amounts previously disclosed in Summary
Compensation Table
Nonqualified Deferred Compensation
Name
Executive
Contributions in
Last FY
($)
Registrant
Contributions in
Last FY
($)
Aggregate
Earnings in
Last FY
($)
Aggregate
Withdrawals /
Distributions
($)
Aggregate
Balance at
Last FYE
($)
PEO
PFO
A
B
C
• Disclosure of all earnings (vs. only when earned and above market) on deferred compensation, that is
not tax-qualified
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Deferred Compensation Narrative
The company must disclose all material factors necessary to understand
table, including:
– types of compensation permitted to be deferred and any deferral
limitations
– the measures of calculating interest or other plan earnings
– material terms with respect to payouts, withdrawals and other
distributions
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Director Compensation Table
• Formatted tabular disclosure now
required, in light of growing complexity
of director compensation programs
Director Compensation
Name
Fees Earned or
Paid in Cash
($)
Stock
Awards
($)
Option
Awards
($)
Non-Equity Incentive
Plan Compensation
($)
Change in
Pension Value
and NQDC
Earnings
($)
All Other
Compensation
($)
Total
($)
A
B
• All other, including:
- Perquisites and
personal
benefits
- Consulting fees
- Director legacy
programs
C
D
E
• Grouping of multiple directors in a
single row permitted, as long as all of
their elements and amounts of
compensation are identical
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• Pension values and nonqualified
deferred compensation earnings
disclosed in separate column
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Director Compensation Narrative

Additional material information necessary to understand tabular
information

Perquisite disclosure required only if value of benefits is $10,000 or
more
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Compensation Disclosure and Analysis

Principles-based disclosure
– CD&A must discuss six specific items:
Program objectives
Behaviors that program is designed to reward




Each element of compensation
Rationale for each element
Methodology (including formula) used to determine amount for each
element
How each element and decisions regarding that element fit into overall
compensation objectives and affect decisions regarding other elements
– Must also discuss any other material information that is necessary to an
investor’s understanding of the executive compensation program
Rules include examples of other potentially material matters to be
discussed



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Compensation Disclosure and Analysis

CD&A will be considered “filed” with, rather than “furnished” to, the
SEC
– Subject to full liability under the federal securities laws

May be included in Securities Act registration statements

Will be included in annual report on Form 10-K and possibly
other Exchange Act reports
– Also subject to CEO/CFO certification requirements when included
in annual report on Form 10-K

CEO and CFO must formally attest to report’s accuracy and
completeness
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Compensation Disclosure and Analysis

Discussion of performance-based compensation
– Must address specifics of performance-based compensation

Specific items of corporate performance used in program

How specific forms of pay are structured to reflect corporate
and/or individual performance
– Need not disclose target measures/levels if:

Involves trade secrets

Involves confidential commercial or financial information, the
disclosure of which would cause competitive harm for company

Standard for determining competitive harm is whether company
could receive confidential treatment of information from SEC
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Compensation Disclosure and Analysis

New discussion of stock option grant practices
– Responds to stock option backdating controversy
– Must address how determination is made as to when awards are granted,
including equity-based compensation such as options
– Must also address option compensation, particularly timing and pricing of
option grants, including
Why the company selects particular dates for granting awards
How option terms and conditions are established, such as how
exercise prices are determined
Whether company has program or practice to coordinate timing of
grants with release of material, nonpublic information and, if so, scope
and nature of arrangement
– Disclosure is in addition to new Grants of Plan-Based Awards Table that
includes information about grant dates, grant date share prices and
exercise prices



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Compensation Disclosure and Analysis

Other issues
– Explaining the compensation-setting process

Should address in manner that emphasizes rationale for each
pay element in context of total compensation

Use of compensation tools

Peer groups and benchmarking

Time period covered
– Discussing compensation of each named executive officer
– Integration with existing disclosure controls and procedures
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Compensation Disclosure and Analysis

Preparing the CD&A:
– Management will prepare draft report
A multi-disciplinary exercise involving executives, directors, HR, legal,
others
– Compensation committee will review draft report and provide input

– CEO and CFO must certify contents of report as included in annual report
on Form 10-K
– New Compensation Committee Report will comprise part of due diligence
process
– Need to coordinate with filing of annual report on Form 10-K
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