The SEC has proposed expanding executive compensation disclosure requirements
for reporting companies. A major focus of the
proposed rules, released July 10, 2009, is the relationship between
compensation policies and risk management.
The additional disclosures would affect disclosure of compensation policies
and their impact on risk taking; stock and options awards; director
qualifications; company leadership structure; the board’s role in the risk
management process; and compensation consultants. The proposed rules also
include amendments to Form 8-K and expand proxy disclosures. The SEC anticipates
that the new requirements will be effective for the 2010 proxy season.
The proposed rules would broaden the Compensation Discussion and Analysis
(CD&A) to include a risk management discussion if the risks from compensation
policies and practices have a material effect on the company. This disclosure
would include material risks for any employee group, not just executive
officers. For example, the disclosure might be triggered if a business unit
carries a significant portion of the company’s risk profile or has different
compensation policies that affect risk management.
When disclosure is required, companies may need to address:
- The general design philosophy of compensation
policies as they relate to risk taking.
- Risk assessment in structuring compensation policies.
- How compensation policies relate to the realization of risks resulting
from the actions of employees in both the short and long term, through, for
example, claw-backs and holding periods.
- The policy for adjusting compensation policy to address changes in the
company’s risk profile.
- Material adjustments made to compensation policies in response to
changes in risk profile.
- The extent to which risk management objectives are consistent with
In general, the proposed rules reflect the SEC’s current view that
compensation policies and attendant risks are a primary cause of the current
economic climate and the need to expand risk management disclosure. SEC
reporting companies will need to evaluate whether risk disclosure is required
and, if so, how and why their current compensation policies and structures
relate to risk management.
Risk Management Process
Consistent with the theme of disclosing risk management issues, the proposed
rules would require disclosure of the board’s role in the company’s risk
management process. This could include, for example, whether the board oversees
risk management at the board or committee level. The disclosure would be focused
on the organization and process, and would not require disclosure of actions
taken by the board.
The SEC has proposed expanding Item 407 of Regulation S-K and Item 7 of
Schedule 14A to require a description of the company’s leadership structure. In
particular, each company would be required to explain why the leadership
structure in place at the time of filing is best for the company, including why
the principal executive officer and board chair positions are combined or
separate. Moreover, each company would be required to disclose whether it has a
lead independent director and the role the lead independent director plays in
the company's leadership.
Stock and Option Awards
The proposed rules would include disclosure of the aggregate grant date fair
market value of stock and option awards, instead of the dollar amount recognized
for the fiscal year for all outstanding awards. The disclosure itself would
continue to be made in the summary compensation table. The intent is to reflect
compensation decisions made in a single year. The transition to the new form of
disclosure will be addressed in the final rule.
The proposed rules would amend Item 401 of Regulation S-K to require expanded
disclosure about incumbent directors and director nominees. The new disclosure
would focus on the specific experience, skills and qualifications that qualify
an individual to serve as a director for the company and on any committee. The
new disclosures represent a significant expansion given that companies currently
are required to provide only brief biographical data for the previous five
years. In addition, any directorships held at public companies within the past
five years would be disclosed instead of only current directorships under
existing rules. The SEC has also proposed extending from five years to ten the
time period for disclosure of legal proceedings involving directors, director
nominees, executive officers and individuals chosen to become executive
The proposed rules also aim to address concerns about potential conflicts of
interest and independence of compensation consultants. If the compensation
consultant provides additional services beyond providing executive and director
compensation recommendations, then the following information must be disclosed:
- The nature and extent of additional services.
- Aggregate fees paid for the additional services and separately for the
executive and director compensation recommendations.
- Whether the decision to engage the consultant for additional services
was made or approved by management.
- Whether the board approved the provision of additional services by the
Form 8-K Requirements
In what may be an effort to prepare companies for future say-on-pay
requirements, the SEC has proposed transferring the requirement to disclose the
voting results of any matter submitted to shareholders for vote from Form 10-Q
and Form 10-K to Form 8-K. The main impact of the transfer is to accelerate
substantially the disclosure of shareholder votes.
Under existing rules, companies must disclose voting results in the Form 10-Q
filed for the quarter in which the meeting is held or, if the meeting is held
during the company’s fourth quarter, in the company’s Form 10-K. The proposed
rules would require companies to disclose voting results on Form 8-K within four
business days after the end of the meeting, with limited exceptions.
Potential Future Developments
The SEC’s announcement of the proposed rules also seeks comment on other
issues that provide insight into the future direction of the SEC on executive
compensation disclosure. One issue raised is whether the CD&A should require
disclosure of performance targets on an after-the-fact basis, regardless of
whether it may result in competitive harm. Another issue is whether the CD&A
should be a part of the Compensation Committee Report and whether the Report
should be filed rather than “furnished” (which would increase potential
liability for the statements in the Report).
Another topic is whether information about the compensation expertise of
compensation committee members should be disclosed. The release also asks
whether there should be additional disclosures regarding the internal pay equity
of a company (i.e., the ratio of compensation of executive officers to
compensation of rank and file employees).
The proposed rules would be effective for the 2010 proxy season. The deadline
for comments is 60 days after publication in the Federal Register.
For additional information or assistance in evaluating your company’s current
compensation and reporting practices, please contact the authors or any member
of the McGuireWoods
Securities & Corporate Finance teams.