On August 11, 2006, the SEC issued its adopting release for the new rules on executive compensation and related party disclosures. Beginning for fiscal years ending on or after December 15, 2006, companies will have to comply with the SEC’s new rules that will substantially revise the disclosure requirements for executive and director compensation and security ownership, related party transactions, director independence, and other corporate governance matters. For calendar year end companies, the new rules will apply to the 2007 proxy statements.
The SEC also issued new rules applicable to disclosure of executive compensation arrangements on Form 8-K that will become effective 60 days after the release is first published in the Federal Register.
Executive and Director Compensation
The Summary Compensation Table has been revised and will include columns reporting dollar amounts for salary, bonus, stock awards, option awards, non-equity incentive plan compensation, change in pension value and nonqualified deferred compensation earnings, and all other compensation. The Summary Compensation Table will also have a new "total compensation" column to sum-up all the foregoing amounts. There will be a new Director Compensation Table, which will require disclosure of director compensation for the last fiscal year in the same format as the Summary Compensation Table. Disclosure of nonqualified deferred compensation earnings in the table will be limited to the above-market or preferential portion. Equity awards will be valued in the table based on the grant date fair value of the award determined pursuant to FAS 123R for financial reporting purposes.
Disclosure of compensation is required for the principal executive officer, the principal financial officer and the three other most highly compensated executive officers. In determining the most highly compensated executive officers, the rules require companies to look at total compensation, but to exclude the increase in pension values and above-market or preferential earnings on compensation that is deferred on a basis that is not tax-qualified, including earnings on non-qualified deferred compensation plans. Companies will not be required to restate prior years’ executive compensation disclosures, and can instead omit years for which disclosure was provided under the old rules.
The dollar value of perquisites must be included in the “all other compensation” column unless the aggregate amount is less than $10,000. The adopting release contains interpretive guidance on what is a perquisite. Previously, perquisites could be excluded from the Summary Compensation Table if the aggregate amount of such benefits did not exceed the lesser of $50,000 or 10% of total annual salary and bonus.
Disclosure of Non-Executive Employee’s Compensation
The SEC did not adopt the proposed rule which would have required disclosure for up to three additional non-executive employees whose compensation exceeds that of any of the named executive officers. However, for "large accelerated filers" (companies with a market capitalization of $700 million or more), the SEC is seeking comment on an alternative proposal to require disclosure of total compensation of up to three non-executive employees who have significant policy-making powers either with the company or within a significant subsidiary, principal business unit, division or function of the company; and whose compensation exceeds that of any of the named executive officers. As proposed, these individuals will only be identified by job title and will not be named.
New Stock Option Grant Disclosure
The new rules will require a new Grants of Plan-Based Awards Table that will include for each grant to a named executive officer during the last fiscal year, disclosure of the grant date as determined for financial statement reporting purposes pursuant to FAS123R, estimated future payouts for both non-equity incentive plans and equity incentive plan awards, the number of shares or units comprising or underlying the award, and the exercise price. An additional column is required to disclose the market price (based on the reported closing price) if the exercise price is less than such market price. An additional column is also required to disclose the date of board or compensation committee action to grant an award if such date is different than the grant date. Further, if the exercise or base price of an option grant is not the closing market price per share on the grant date, companies must describe the methodology for determining the exercise or base price, either by footnote to the table or in the accompanying narrative section.
New Narrative Disclosure
In order to give context to the tabular disclosures in the Summary Compensation Table and the Grants of Plan-Based Awards Table, a company is required to provide a narrative description of any additional material factors necessary to an understanding of information disclosed in the tables. This disclosure differs from the Compensation Discussion and Analysis ("CD&A") report described below, which will focus on broader topics. An example of the narrative disclosure might include terms of the executive’s employment agreement which give context to the tabular disclosures.
Retirement Plan and Post-Employment Disclosure
A new Pension Benefits Table will require disclosure of the actuarial present value of each named executive officer’s accumulated benefit under each pension plan, computed using the same assumptions (except for the normal retirement age) and measurement period as used for financial reporting purposes under GAAP. A new Nonqualified Deferred Compensation Table will require disclosure with respect to nonqualified deferred compensation plans of executive contributions, company contributions, earnings for the year, withdrawals/distributions, and the year-end balance.
Companies must also provide a narrative description of any arrangement that provides for payments or benefits at, following, or in connection with any termination of a named executive officer, a change in responsibilities, or a change in control of the company, including quantification of these potential payments and benefits assuming that the triggering event took place on the last business day of the company’s last fiscal year and the price per share was the closing market price on that date. This includes quantitative disclosure of tax gross-up provisions and non-monetary benefits such as perquisites and health care benefits. Where uncertainties exist in the calculations, companies must make reasonable estimates and disclose the material assumptions underlying the estimates.
Compensation Discussion and Analysis
There will be a new CD&A section, which will address the objectives, implementation and factors underlying each element of compensation paid to named executive officers. This section will be "filed" with the SEC and subject to the certification by a company’s principal executive officer and principal financial officer. Companies will also be required to furnish a compensation committee report similar to the audit committee report, stating whether the compensation committee has reviewed and discussed with management the CD&A and, based on that review and discussion, whether the committee recommended to the company’s board of directors that the CD&A be included in the company’s proxy statement and annual report on Form 10-K.
The CD&A report must include an explanation of equity award grant methods and timing, including the existence of a program, plan or practice to time the grant of options to executives in coordination with the issuance of material non-public information.
Related Party Transactions
The threshold for reporting related-party transactions has been increased from $60,000 to $120,000, and companies will have to disclose their policies and procedures for reviewing and approving or ratifying related party transactions.
Revised Form 8-K Rules
The new rules relieve the prior interpretation of the SEC Staff that nearly all compensation arrangements with any executive officer or director need to be disclosed on Form 8-K. Item 1.01 of Form 8-K will no longer cover material agreements involving executive compensation, which disclosures will instead be consolidated in an expanded Item 5.02. Item 5.02 currently applies to the appointment or resignation of directors and certain executive officers. Under the new rules, Item 5.02 will require disclosure of material compensation arrangements entered into or amended in connection with appointment or resignation of covered officers.
In addition, disclosure will be required in Item 5.02 of material compensation arrangements, including grants and awards, entered into or amended as to which the principal executive officer, principal financial officer or any named executive officer is a party. For this purpose, named executive officers will be those named in the most recent filing which contains required executive compensation disclosure (usually, the last annual meeting proxy statement). This new disclosure will be a “safe harbor” item like Item 1.01, so failure to timely disclose will not affect Form S-3 eligibility or create liability under Rule 10b-5. The balance of Item 5.02 does not have the benefit of the safe harbor. Finally, Item 5.02 will require disclosure of annual salary and bonus information for the most recent completed fiscal year that is not disclosed in the proxy statement as a result of not being determinable at the time of filing the proxy statement. This disclosure will also require a new total compensation recalculation to reflect the new salary or bonus information.
The above is just a brief summary of the comprehensive new rules. The SEC’s press release summarizing the new rules is available at http://www.sec.gov/news/press/2006/2006-123.htm and the SEC’s adopting release of the final rules (436 pages) is available at http://www.sec.gov/rules/final/2006/33-8732.pdf.
Companies should be planning ahead for their 2007 proxy statements and evaluating their disclosure controls and procedures to ensure the efficient gathering of the information that will need to be disclosed. Companies should also be reviewing their procedures relating to option granting and policies relating to the approval and ratification of related party transactions with an eye toward disclosure of those policies. We recommend that companies work with their legal counsel to prepare a “dry-run” of the anticipated year-end disclosures in order to highlight the issues, uncertainties, and calculations that will need to be addressed in 2007 proxy statements. Companies should also consider adjusting their annual meeting schedules to include additional time for preparation and legal review of the new disclosures.
For further information or questions on the SEC’s new rules on executive compensation and related party disclosure, please contact John D. Tishler at (858) 720-8943.